-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MeBhU64CVGh6bUkkHG7/4xv1KBXicX+3nQekGUdACSwHyLV/ZxjHD/8vCDbC6WgZ qVzJNs55xQFjk4+irUfIfw== 0001013708-98-000053.txt : 19980430 0001013708-98-000053.hdr.sgml : 19980430 ACCESSION NUMBER: 0001013708-98-000053 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980428 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: MEDIZONE INTERNATIONAL INC CENTRAL INDEX KEY: 0000753772 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-DRUGS PROPRIETARIES & DRUGGISTS' SUNDRIES [5122] IRS NUMBER: 870412648 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 002-93277-D FILM NUMBER: 98602103 BUSINESS ADDRESS: STREET 1: P.O. BOX 742 CITY: STINSON BEACH STATE: CA ZIP: 94970 BUSINESS PHONE: 4158680300 MAIL ADDRESS: STREET 1: P.O. BOX 742 CITY: STINSON BEACH STATE: CA ZIP: 94970 FORMER COMPANY: FORMER CONFORMED NAME: MADISON FUNDING INC DATE OF NAME CHANGE: 19860413 10-K/A 1 ANNUAL REPORT Item 5 and Item 8 were subjects of a Form 12b-25 and are now included in this report SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------------- FORM 10-K/A ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 Commission File Number: 2-93277-D MEDIZONE INTERNATIONAL, INC. (originally Madison Funding, Inc.) ---------------------------------------------------------------- (Exact name of Registrant as stated in its corporate charter) Nevada 87-0412648 - ----------------------------------------------------------------------- (State of incorporation) (I.R.S. Employer I.D. Number) 4505 South Wasatch Boulevard, Suite 210, Salt Lake City, Utah 84124 - ----------------------------------------------------------------------- (Address of principal executive offices) (Zip code) Registrant's telephone number: (801) 274-8400 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None The Registrant has (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is contained herein, and will be contained in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment hereto. Yes No X The aggregate market value of voting common stock held by non-affiliates of the Registrant was $65,789,197 on March 30, 1998, based on the average bid and asked prices of such stock as reported in the NASD OTC Bulletin Board and the "pink sheets" of the National Daily Quotation Bureau. According to information received from Registrant's transfer agent, as of March 17, 1998, Registrant had 138,609,519 shares outstanding (of which 41,490,125 were restricted). DOCUMENTS INCORPORATED BY REFERENCE: None SUPPLEMENTAL INFORMATION: The Registrant intends to furnish its shareholders with an annual report for 1997 and a proxy statement subsequent to the filing of the 10-K. TABLE OF CONTENTS PART I Page Item 1. Business..........................................................3 Item 2. Properties.......................................................10 Item 3. Legal Proceedings................................................10 Item 4. Submission of Matters to a Vote of Security Holders...........................10 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters..................11 Item 6. Selected Financial Data..........................................13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..............................................13 Item 8. Financial Statements and Supplementary Data....................................................15 Item 9. Changes in and Disagreements with Accountants on Auditing and Financial Disclosure..............................................15 PART III Item 10. Directors and Executive Officers.................................15 Item 11. Executive Compensation...........................................19 Item 12. Security Ownership of Certain Beneficial Owners and Management........................24 Item 13. Certain Relationships and Related Transactions............................................26 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................28 Signatures..............................................28 Exhibits Index..........................................E-1 Financial Statements and Schedules......................F-1 -2- PART I Item 1. Business -------- General Medizone International, Inc., a Nevada corporation (the "Company" or the "Registrant") organized in 1986, is a development stage company whose objective is to (i) gain regulatory approval for its drug, a precise mixture of ozone and oxygen called MEDIZONE(R), and its process of inactivating lipid enveloped viruses for the intended purpose of decontaminating blood and blood products and assisting in the treatment of certain diseases; and (ii) develop the related technology and equipment for the medical application of its products, including its drug production and delivery system (the "Medizone Technology"). MEDIZONE(R) is one of two registered trademarks of the Company. Throughout this report, whether or not the trademark symbol is used, the phrase "Medizone (the drug)" is intended to have the same effect as if the trademark symbol had been used. Medizone (the drug) is intended to be used as a therapeutic drug in humans to inactivate certain viruses, and thereby afford a treatment for certain virally-based diseases (including Human Immunodeficiency Virus ["HIV"], the AIDS related virus, Hepatitis B, Epstein-Barr, herpes, and cytomegalovirus), and to decontaminate blood and blood products, applications which are covered under the Company's patent (Patent No. 4,632,980). The Medizone Technology was developed for the production of Medizone (the drug), and has led to the design of equipment for which a patent has been issued in the United States (Patent No. 5,052,382). The Company has obtained patents based on each of these patents in various foreign countries. See "Patents". Patents The proprietary scope of the Company is covered under a United States process patent (U.S. Patent No. 4,632,980) entitled, "Ozone Decontamination of Blood and Blood Products" (the "Patent") and a related United States equipment patent (U.S. Patent No. 5,052,382) entitled "Approaches for the Control Generation and Administration of Ozone" (the "Equipment Patent"). The Patent, which covers a procedure for ozone decontamination of blood and blood products through the treatment of blood and blood components, is the Company's principal asset, and was purchased, together with rights to other ozone-related inventions, from Immunologics Limited Partnership, L.P. ("ILP") in 1987, for an aggregate of 6,000,000 shares of the Company's common stock (the "Patent Purchase Agreement"). John M. Kells, the general partner of ILP, was Chairman of the Company's Board of Directors from November 1992 through September 1993. The Patent Purchase Agreement requires the Company to pay to ILP an annual royalty equal to 3% of the net receipts (i.e., net receipts after all credits, returns and customary deductions, and exclusive of all taxes) received by the Company in connection with the sale of any product, device or apparatus embodying the Patent. The method covered by the Patent is the principal use of ozone under study by the Company and is the method incorporated in its regulatory applications. (See "Governmental Regulation" below.) In June 1990, pursuant to the Company's request for re-examination of the Patent, the U.S. Patent Office issued a re-examination certificate, confirming the patentability of the claims covered by the Patent. The Company's United States patent protection for the Patent will expire in 2003, subject to extension based upon the length of time required to bring the Patent to commercial fruition. The Company has been granted patents (based on the Patent) in Canada and the European Patent Community, Australia, Malaysia, Hong Kong and Japan, with -3- applications pending in Singapore. The foreign patents began to be issued in 1990 and will expire 17 years after their respective dates of issuance. The Equipment Patent, which covers apparatus for the controlled generation, monitoring and dosage of a precise admixture of ozone and oxygen (Medizone, the drug), was developed by a consultant engineer to the Company and issued and assigned to the Company in 1991. The Equipment Patent was developed to provide the physical means to deploy the Patent. The foreign patent coverage of the Equipment Patent parallels the coverage of the Patent. In late 1996, the Company became aware that a United States patent had been issued to a Canadian corporation which it believes infringes on the Patent. The Company has consulted its patent counsel and intends to take the appropriate steps to protect its rights with respect to the Patent. However, at the present time, the nature of any action to be taken by the Company has been and will continue to be limited by its lack of funding. Research and Development The Company does not maintain laboratories or other clinical research or testing facilities. The Company's research and development activities have been conducted by utilizing contract laboratories and clinicians. The research and development activities have been directed by the Company's Scientific Advisory Board, whose sole member since June 1997 has been Dr. Gerard V. Sunnen, the Company's Director of Science (see "Employees and Consultants"). Pre-clinical Studies Pre-clinical Studies are defined as non-human studies. Since 1988, the Company has both sponsored and been the beneficiary of research to determine, among other things, (i) whether the use of ozone, either alone or with other modalities, is efficacious in the treatment of certain diseases and (ii) to establish additional scientific evidence that ozone, through the use of the patents and/or applications of scientific methodologies of a similar nature can decontaminate blood of lipid enveloped viruses and thereby significantly diminish the degree of transfusion related disease. Pre-clinical projects sponsored by the Company to date include: (1) studies to test ozone's ability to inactivate HIV, conducted at the State University of New York ("SUNY") Health Science Center at Syracuse; (2) a pilot animal study of the potential toxicity of ozone, conducted by the Arnold & Marie Schwartz College of Pharmacy and Health Science at Long Island University; and (3) studies investigating the effects of ozone/oxygen admixtures on human peripheral blood, including whole blood, serum and plasma, conducted by the Blood Bank of Mt. Sinai Medical Center, New York City. In 1990, the Canadian Blood Forces Program (under the aegis of the Canadian Department of Defense and Agriculture and the Canadian Red Cross) requested that the Company add the Medizone Technology to the other proprietary technology being investigated as an experimental arm of an ozone- based blood sterilization investigative program. The program was an attempt to develop an effective technology for sterilizing whole blood and blood products. This program, which was to study the Medizone Technology as it relates to the inactivation of Simian Immunodeficiency Virus ("SIV"), included a live primate model. The program continued until 1994, completing two out of the three proposed stages, when the funding arm of the Canadian Blood Forces Program discontinued funding the program. The Company's current management learned in late 1997 that the program, as it involves the Medizone Technology, was stopped primarily due to an equipment failure and the generation of erroneous data due to the equipment failure. The third stage of the study was resumed in May 1996, but did not utilize the Medizone Technology. -4- Governmental Regulation Medizone (the drug), the Medizone Technology and any related products derived therefrom are regulated under the Federal Food, Drug and Cosmetic Act and the regulations promulgated thereunder (the "FDC Act") and are regulated by the Food and Drug Administration (the "FDA"). The FDA exercises broad and extensive authority in regulating the development, production, importation, distribution and promotion of "new drug" products and "investigational devices" pursuant to the FDC. Because ozone-generation for the purposes of interfacing with blood and blood products is regarded as a new drug delivery system, the Company is precluded from selling or distributing Medizone (the drug) or the Medizone Technology until after FDA approval has been granted. In order to obtain FDA approval, the Company will be required to submit medical and scientific evidence sufficient to demonstrate that Medizone (the drug) and the Medizone Technology has been successfully used in pre- clinical studies followed by well-controlled clinical studies using human volunteer subjects. The FDA will not grant an NDA unless it contains sufficient medical evidence and data to permit a body of qualified and experienced scientists to conclude that the new drug product is safe and effective for its recommended and proposed medical uses. Historically, the FDA has held a strong bias against treating humans with ozone, due largerly to issues of safety. In order to initiate the first phase (i.e., Phase I) of human clinical studies required as part of an NDA, an applicant must submit to the FDA an application for an Investigational New Drug Exemption ("IND"), which contains adequate information to satisfy the FDA that human clinical studies can be conducted without exposing the volunteer human subjects to an unreasonable risk of illness or injury. The Compay submitted an IND application (assigned to the Registrant by its former president) to the FDA on October 6, 1985, and requested FDA approval to commence human clinical trials using ozone- oxygen to inactivate HIV. The FDA deemed the IND application to be incomplete, and required the Company to conduct additional animal studies prior to commencing a large animal study and human trials. In September 1994, after not receiving responses to requests for information from the Company, the FDA inactivated the Company's IND. The Company has no present plans to commence a large animal study, which would require, as a precursor, additional small animal and laboratory work. Accordingly, there can be no assurance that the Company's IND application will ever be re-opened. Until an NDA has been granted to the Company, it may not distribute ozone-generating devices, except to researchers who agree to follow FDA guidelines, and provided the devices are labeled as "Investiga- tional Devices." Because ozone has been used to treat humans in Europe for at least 30 years, the European Union (the "EU") is more accepting of human clinical trials of ozone therapies being conducted than is the United States. Accordingly, Management believes that the Company should pursue the option of conducting human clinical trials in Europe, using stringent protocols that will meet EU standards, with a view to utilizing the results of such trials in an effort to obtain EU approval and to re-open the Company's FDA file. Clinical Studies Overview To date the Company has not performed any human clinical studies. The Italian Initiative -5- In late 1992, the Italian Ministry of Health suspended the clinical use of ozone until such time as sufficient scientific evidence was available to support its use as a human therapeutic treatment. In this regard, the Italian Ministry of Health designated the Italian Scientific Society for Ozone-Oxygen Therapy in Bergamo, Italy ("ISSOT") as the agency to select those treatment protocols utilizing ozone as worthy of investigation and to provide those protocols to the Italian Ministry of Health for review and approval. By letter agreement dated March 23, 1993, with ISSOT, the Company entered into a collaborative arrangement to research and examine the efficacy of the Medizone Technology in the treatment of various blood-related human diseases. The research is to be supervised by ISSOT in Italy, under the direction of a research group assembled by the Italian Ministry of Health. The research is to be conducted in accordance with protocols that will meet EU Standards for human clinical trials (to be furnished by the Company) at University based hospitals, which will enter into agreements with the Company on a site by site basis. The ISSOT letter agreement requires the Company to furnish ozone-generating instruments for use in the trials and to pay for laboratory tests performed by each testing institution that are outside the scope of the normal realm of clinical analyses performed by the testing institutions. There can be no assurance that any of the data generated from the ISSOT research will be permitted to be utilized in connection with the Company efforts to re-open the FDA IND (see "Governmental Regulation"). On May 16, 1994, the Company announced that human trials were to commence at the University of Naples ("Naples"). However, after the termination of Joseph S. Latino's employment with the Company's, the Company's inquiry into the conduct of its operations during Dr. Latino's tenure as its Chairman, President and Chief of Research disclosed that human trials of the Company's ozone therapy on patients infected with either Acquired Immunodeficiency Syndrome (AIDS) or Hepatitis B (chronic active) has not been authorized by Naples or commenced at that institution. The Company also learned that the Italian Ministry of Health had not issued approvals for human clinical trials to commence at certain sites as previously disclosed. While the ethics committees at certain university hospitals have stated their approval for the Company to conduct Phase II trials, they would require the Company to have either completed a large animal study and Phase I trials or to have these requirements waived. The Company has never performed a large animal study or Phase I clinical trials and does not possess the necessary data with respect to its ozone therapy to commence Phase II study. However, there does exist a broad use and understanding of ozone therapy throughout Europe and there have been numerous scientific articles published in European medical journals describing the use of ozone on humans. The Company has held discussions with an Italian Contract Research Organization (the "ICRO") with a view to having the ICRO act as an intermediary on behalf of the Company with the Italian Ministry of Health and prepare a written submission to the Italian Ministry of Health regarding the data in the public domain on ozone therapy with a view to having the Italian Ministry of Health accept this material as proof of safety, toxicity and tolerance of the use of the Company's ozone technology on humans in lieu of having the Company perform a large annual study and possibly even a Phase I clinical study. The ICRO would also design a research program and protocols for clinical trials which would meet the standards of the EU and FDA, monitor the clinical terms and collect and prepare analyses of the data produced by the trials. The Company will not be able to enter into a formal contract with ICRO unless it obtains additional funding. If the Italian Ministry of Health does not accept the published evidence on the use of ozone therapy on humans, the Company will be required to perform its own Phase I clinical trials and possibly a large animal study. In late 1997, the Company entered into a discussions with Italian and Belgium clinicians with regard to them performing Phase I clinical studies. However, assuming the Italian Ministry of Health did not grant the Company's request for a waiver, no formal agreements with these clinicians would be signed and the studies would not begin until the Company obtains additional funding. The Company estimates that it would require an infusion of approximately $1.5 million to advance the above-described research initiatives through the completion of a Phase III study and submission of the data for approval to the Italian Ministry of Health. Instrument Development On October 17, 1996, the Company executed an agreement with Multiossigen, S.r.L., an Italian corporation located in Bergamo, Italy (the "Manufacturer"), dated as of September 13, 1996 (the "Equipment Contract"), providing for the manufacture of ozone generating devises to be used in the human trials to be commenced pursuant to the Company's letter agreement with the ISSOT, as trials are approved by the Italian Ministry of Health. -6- Pursuant to the Equipment Contract, the Manufacturer will produce a working prototype of ozone generating devices dedicated to the use of hollow fibers or similar gas exchange technology covered under the Company's patents, satisfactory to the Company (the "Equipment"), and will make all data generated from the use of the Equipment available to the Company. The Equipment Contract calls for the Manufacturer to manufacture twenty pieces of the Equipment at a purchase price of $9,000 per unit, for an aggregate of $180,000, payable as follows: (a) $25,000, paid upon approval of the prototype; (b) $55,000, payable in fifteen installments of $3,667 with five such installments ($18,335) being paid on each delivery of five units of the Equipment; and (c) one million shares of the Company's common stock, bearing a restrictive legend, 500,000 shares of which were issued on the date the Equipment Agreement was executed with the remaining 500,000 shares issued on March 16, 1997. Pursuant to the Equipment Agreement, the Company granted to the Manufacturer a license to use the Company's patents in Europe, subject to the regulations of all documents necessary to protect the Company's rights in and to the patents, and appointed the Manufacturer as the Company's exclusive manufacturer and distributor of the Equipment in Europe. Notwithstanding the forgoing, the present distribution of the Equipment shall be limited to Italy, but such distribution will be expanded to the rest of Europe upon the mutual agreement of the parties. The Equipment Agreement (together with its grants of license and distribution described above) will terminate on September 13, 1998 and may be renewed by mutual agreement of the partners at least thirty days prior to the end of its term. Units of Equipment shall be delivered in lots of five units and shall be deliverable to the appropriate hospital site within 60 days of the written request by the Company, based upon such hospital's ethics committee granting approval to committee trials at a particular site. Since its organization, the Company has attributed $2,202,685 as expenditures for research and development, including $25,000 in 1996. International Activities Medizone Canada Limited ----------------------- In order to maximize both research opportunities and the potential market for its products, the Company intends to establish subsidiary or affiliated corporations in other countries. The organization of such subsidiaries may initially require the Company to incur significant expenses; thereafter, it is intended that the subsidiaries would be responsible for organizing research programs and/or generating possible sources of financing, from which the Company would benefit directly or indirectly. It is anticipated that the Company would also enter into license agreements with all subsidiary companies. Registrant owns approximately two-thirds of the equity of Medizone Canada Limited, a publicly-owned Utah corporation ("MCL"), which is engaged in the same business as the Registrant in Canada through its wholly-owned subsidiary, MCL Medizone Canada Ltd. ("MedCan") As described above under "Research and Development", MedCan was a participant in the Canadian Blood Forces Program's SIV Study. Four million redeemable common stock purchase warrants, each exercisable to purchase one share of the common stock of MCL for $.125, are publicly-held. The MCL warrants originally had a nine month exercise period. The expiration date was extended numerous times (but expired on December 31, 1997.) -7- Medizone New Zealand Limited ---------------------------- On June 22, 1995, the Company entered into a series of contracts (collectively the "Transaction Documents") which resulted in the formation of a joint venture subsidiary incorporated in New Zealand, Medizone New Zealand Limited ("MNZ"). MNZ, a privately held corporation equally owned by the Company and Solwin Investments Limited ("Solwin"), a New Zealand corporation which is an affiliate of Richard G. Solomon ("Solomon"), who became a director of the Company on January 16, 1996, but later resigned on February 27, 1997, was organized on June 22, 1995 and is a research and development stage company whose objective is to obtain regulatory approval for the distribution of the Company's patented technology in New Zealand, Australia, South East Asia and the South Pacific Islands. Pursuant to the Transaction Documents, the Company purchased one hundred percent of MNZ from Solomon, who had caused the formation of MNZ on June 22, 1995. Contemporaneously with this transaction, the Company sold fifty percent of MNZ to Solwin, a corporation owned by Solomon, for U.S. $150,000, of which $50,000 was thereupon loaned by the Company to MNZ on a demand basis, which was repaid on October 26, 1995. On October 26, 1995, the Company loaned MNZ $50,000 on a demand basis, which has not been repaid as of the date of this report. The Directors of MNZ, as of September 1997, are Solomon and Milton Adair, the Company's President. Contemporaneous with the creation of the above share structure, the Company and MNZ entered into a Licensing Agreement (the "Licensing Agreement") and a Managing Agent Agreement (the "Managing Agent Agreement") with MNZ. Pursuant to the Licensing Agreement, the Company granted an exclusive license to MNZ for its process and equipment patents and trademark in New Zealand. MNZ has agreed to apply for corresponding patent protection for these patents in New Zealand and to use its best effort to exploit the rights granted in the agreement. The License Agreement shall terminate on the date of the expiration of the last to expire of any patent obtained in New Zealand, or, if no such patents are obtained, on June 22, 2010. The Company is to receive a guaranteed minimum royalty (the "Guaranteed Minimum Royalty"), in an amount to be agreed to by the Company and MNZ, commencing in the third year after all necessary regulatory approvals requisite to the license, use or distribution of the Company's proprietary technology have been obtained in New Zealand. If the Company and MNZ are unable to agree upon the amount of the Guaranteed Minimum Royalty, the Company may terminate the license on thirty days' notice. Commencing on the first sale to a user by MNZ, the Company shall receive a sales royalty in an amount equal to ten percent of MNZ's gross annual sales under the License Agreement. Pursuant to the Managing Agent Agreement, MNZ will act as the Company's agent in the finding of other licensees of the Company's patents and trademark in the following countries: Australia (including Australia and New Zealand), the South Pacific Islands and South East Asia (including the Philippines, Indonesia and Vietnam). Licensing fees obtained as a result of the Managing Agent Agreement shall be divided between the Company and MNZ on a sliding scale as set forth below: The Company MNZ ----------- --- Initial license 50% 50% Subsequent license fees up to $500,000 50% 50% Subsequent license fees between $500,000 and $750,000 75% 25% Subsequent license fees in excess of $750,000 85% 15% -8- MNZ and the Company will also divide any net royalties paid to the Company pursuant to any license obtained pursuant to the Managing Agent Agreement, with MNZ being paid 10% of the net royalties and the Company receiving 90% of the net royalties. The Managing Agent Agreement shall expire on the termination or expiration of the last of the licenses obtained pursuant thereto, subject to earlier termination by the Company upon an occurrence of certain events. Competition The area in which the Company seeks to do business is extremely competitive. The Company is aware of a number of domestic companies that have commenced research into the use of ozone as a virucide in the treatment of HIV and other diseases, or have announced the intention to do so. Other companies, foundations, research laboratories or institutions may also be conducting similar investigations into the use of ozone as a virucide or as a decontaminant for blood or blood products. The Company is also aware that another company has provided ozone-generating equipment to departments of the Canadian government conducting studies in Canada for the purposes of comparison of technologies. In addition, as reported in scientific journals and newspapers, there are many commercial, not-for-profit and governmental agencies investigating possible treatments for HIV and other viral diseases, as well as a variety of methodologies aimed toward blood fractionate decontamination. Employees and Consultants The Company has three employees, its President, its Vice President/Chief Financial Officer and a Vice-President of Operations (who is not an officer of the Company). The Company has established a Scientific Advisory Board which suggests and formulates avenues of research and reviews research in progress. As of December 31, 1996, the Scientific Advisory Board was comprised of two members, Joseph S. Latino, Ph.D., the Company's President and Chief Executive Officer and Bernard J. Poiesz, M.D., Head, Regional Oncology Center, S.U.N.Y. at Syracuse, Syracuse, New York. The Scientific Advisory Board met three times in 1996. Dr. Poiesz was not compensated by the Company for his services on the Company's has Scientific Advisory Board, although he has applied for research grants in connection with the Company's research and development efforts. Dr. Poiesz became a member of the Scientific Advisory Board in 1987. From 1989 to 1995, Fred Quimby, D.V.M., Ph.D., Chairman, Animal Research Institute, New York State School of Veterinarian Medicine, Cornell University, was a member of the Scientific Advisory Board, but resigned when he became the sole principal investigator for the SIV Study being conducted under the auspices of the Canadian Blood Forces Program. See "Research and Development". In June 1997, the Scientific Advisory Board was reorganized. It currently has one member, Dr. Gerard V. Sunnen, who serves as the Company's Director of Science. The Company retains CTC, Inc. ("CTC"), of Cincinnati, Ohio, to act as the Company's liaison with the brokerage community. The agreement is for a period of one year, but may be extended by the parties for additional one year periods. CTC receives a monthly payment of $2000, plus expenses. Insurance The Company presently has no product liability insurance, since none of its products are in clinical use. It presently has no officers and directors liability insurance. -9- Certain Business Risks Associated with the Company Development Stage Company/Net Losses ------------------------------------ Although the Company was incorporated in 1986, it is still in the development stage and has not yet commenced full operations, nor has it earned any revenues. No assurance can be given that its business activities will ever generate revenues. As indicated in the Company's financial statements, it has experienced substantial losses throughout its history. Such losses can be expected to continue for the foreseeable future. No Revenues/Need for Additional Financing ----------------------------------------- The Company has generated no revenues, has had no source of funds other than through the sale of its common stock and will require substantial additional capital, which will most likely be obtained through sales of its common stock, in order continue the research program outlined above, pay its administrative and operating expenses, meet its filing and disclosure obligations as a public company, and repay certain outstanding indebtedness. No assurances can be given that the Company will be able to obtain sufficient additional capital for it to continue its research program, or that any additional financing will be sufficient to satisfy the Company's administrative and operating expenses for any significant period of time. Status of the Company's Research -------------------------------- As described above, the Company's research has not progressed to a point where it would be appropriate to predict when, if ever, Medizone (the drug) and the Medizone Technology would have commercial application or be marketable. Forward-Looking Information May Prove Inaccurate This Form 10K/A contains forward-looking statements and information that are based on management's beliefs as well as assumptions made by and information currently available to management. When used in this document, the words "anticipate," "believe," "estimate," and "expert," and similar expressions are intended to identify forward-looking statements. Such statements reflect the Company's current views with respect to future events and are subject to certain risks, uncertainties and assumptions, including the specific risk factors described above. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, believed, estimated or expected. The Company does not intend to update these forward-looking statements and information. Item 2. Properties ---------- As of January 1997, Registrant leased from an unaffiliated party approximately 900 square feet of office space at 123 East 54th Street, Suite 7B, New York, NY 10022, under a two-year lease expiring on February 28, 1998, at an annual rental of $20,940. The Company terminated this lease in June 1997 and paid $4,598.96 to the landlord in settlement of any claim for unpaid rent under the lease. On September 23, 1997, the Company entered into a three-year lease with an unaffiliated third party for its present offices at 4505 South Wasatch Boulevard, comprising approximately 1400 square feet, at an annual rental of $22,984.56. The office space is used for executive offices and administrative purposes. Item 3. Legal Proceedings ----------------- In November 1992, the Company consented to the entry of a final judgment of permanent injunction (S.E.C. v. Medizone International, Inc., Civil Action 93-2761, D.D.C.), pursuant to which the Company was permanently enjoined from failing to timely file the reports required to be filed pursuant to the Securities Exchange Act of 1934. -10- Item 4. Submission of Matters to a Vote of Security Holders. No matters ----------------------------------------------------- were submitted to a vote of No matters were submitted to a vote of securities holders during the fourth quarter of the fiscal year ending December 31, 1997. Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. ------------------------------------------------- Prices/Trading Market Information The Company's shares are traded in the over-the-counter market, with price quotes listed on the NASD Electronic Bulletin Board under the trading symbol "MZEI," and in the "pink sheets" published by the National Quotation Bureau. On March 30, 1998, according to the NQB Non-NASDQ Price Report furnished by the National Quotation Bureau, there were approximately 18 marketmakers in the Company's shares, with a high bid for the shares of $.1055 and a low bid of $.05. Such prices reflect interdealer prices without retail markup, markdown or commission; are not necessarily representative of actual transactions, or of the value of the Company's securities; and are, in all likelihood, not based upon any recognized criteria of securities valuation as used in the investment banking community. Shown below is information obtained from the National Quotation Bureau, indicating the high bid and low bid prices for a share of the Company's common stock at the end of each of the four calendar quarters of fiscal 1996 and 1997, representing prices between dealers which do not include retail markup, markdown or commission. They do not reflect actual transactions. Bid Price --------- Calendar Period High Low --------------- ---- --- 1996 First Quarter .10 .075 Second Quarter .17 .11 Third Quarter .15 .10 Fourth Quarter .125 .075 1997 First Quarter .085 .01 Second Quarter .0825 .05 Third Quarter .105 .085 Fourth Quarter .10 .065 Number of Holders On March 18, 1998, according to the Company's transfer agent, there were 3891 holders of record of the Company's par value $.001 common stock. Dividends The Company has never paid cash dividends on its common stock. Payment of cash dividends is subject to the discretion of the Board of Directors and is dependent upon various factors, including the Company's earnings, capital needs and general financial condition. The Company does not believe that it has any immediate prospect of earnings. However, the Company anticipates that in the foreseeable future, it will follow a policy of retaining earnings, if any, in order to finance research and development. -11- Private Sales of Shares In June 1997, the Company issued warrants to purchase an aggregate of 73,333,333 shares of its common stock to The Sand Dollar Solution ("Sand Dollar"), a California limited partnership, whose general partner is Edwin G. Marshall, the Chairman of the Company's Board of Directors (the "Sand Dollar Warrants"). No consideration was paid to the Company for the Sand Dollar Warrants. The Sand Dollar Warrants have the following exercise prices and expiration dates: Shares Exercise Price Termination Dates - ------ -------------- ----------------- 15,000,000 $.07 per share Originally September 7, 1997, then extended until ten days after the Company becomes current in its filings with Securities and Exchange Commission, now extended to May 31, 1998 33,333,333 $.15 per share June 9, 1998 25,000,000 $.20 per share June 9, 1999 On September 23, 1997, Sand Dollar purchased 5,714,285 shares of the Company's common stock pursuant to the Sand Dollar Warrant, paying $.07 a share, or aggregate consideration of $400,000, which shares were authorized for issuance in December 1997. In March 1998, Sand Dollar purchased 857,143 shares of the Company's common stock pursuant to the Sand Dollar Warrant, paying $.07 a share, or $60,000. The Company relied on the private offering exemption from registration under the Securities Act of 1933 (the "Securities Act") in issuing the Sand Dollar Warrants and for the sale of shares pursuant to the exercise of the Sand Dollar Warrants. In March and May 1997, the Company issued an aggregate of 2,716,600 shares of its common stock to Kenneth Gropper (500,000 shares), Arthur P. Bergeron (500,000 shares), George Handel (750,000 shares), counsel to the Company (an aggregate of 666,666 shares), an employee (50,000 shares), and its public relations firm (250,000 shares) in consideration of services rendered, relying on the private offering exemption under the Securities Act. In December 1997, the Company authorized the issuance of 100,000 shares of common stock to Dr. Gerard Sunnen in consideration of his services as the Company's Director of Science. The Company issued 103,200 shares of its common stock to an employee of its New Zealand subsidiary, pursuant to Regulation S promulgated under the Securities Act, as consideration for services rendered. -12- Item 6. Selected Financial Data.
Year Ended December 31, 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Operations Data: Revenues $ -0- $ -0- $ -0- $ -0- $ -0- Net income (775,559) (1,329,395) (1,081,027) (1,126,315) (1,598,342) (loss) before minority interest Net income (loss) (775,559) (1,329,395) (1,081,027) (1,126,315) (1,598,342) Net income (loss) (.01) (.01) (.01) (.01) (.02) per common share Weighted average 133,568,000 118,022,000 111,306,000 98,292,000 93,384,000 common shares outstanding Balance Data Sheet: Working capital (945,859) (949,254) (538,102) (576,101) (2,844,085) (deficiency) Total assets 307,019 74,368 124,653 87,230 81,705 Long-term -0- -0- -0- -0- -0- liabilities Accumulated (13,217,678) (12,442,119) (11,112,724) (10,103,503) (9,196,610) (deficit) Stockholders' (886,167) (885,241) (432,880) (558,679) (2,825,458) equity deficiency
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. ---------------------------------------------- Results of Operations General ------- From its organization in January 1986, Registrant has been a development stage company primarily engaged in retaining research consultants and sponsoring research to investigate the medical uses of ozone. Registrant has not generated, and cannot predict when or if it will generate, sufficient cash flow to fund its continuing operations. Since its organization, Registrant has attributed $2,319,635 as expenditures for research and development, including $111,950 in 1997. Restatements Registrant has restated each of its quarterly reports for 1992 to account properly for the proceeds from the Company's sale of a portion of its holding of Medizone Canada Limited ("MCL") as equity transactions. -13- During the first quarter of 1992, Registrant sold 250,000 shares of MCL common stock at per-share prices ranging from $.093 to $.10, and during the third quarter of 1992, an additional 150,000 shares were sold through a broker. Aggregate proceeds from the transactions were $24,555 (first quarter) and $24,470 (third quarter), respectively. Because the Company's investment in MCL was only $2, the $24,555 and $24,470 was reported as a gain in the Company's statement of operations for each respective period. In the restated reports, the transactions have been characterized as equity transactions. The restatements result in an increase in the first quarter loss in the amount of $24,555, and an increase in the third quarter loss in the amount of $24,470. Additionally, the Company sold 100,000 shares of MCL common stock during 1991 through a broker for $5,000, at a per-share price of $.05. This transaction was also restated in 1992, as an equity transaction, which results in an increase in the 1991 loss of $5,000. The restatements do not affect previously reported loss per share because of rounding. Years Ended December 31, 1997, and December 31, 1996. There were no sales during either year. Sales commenced in May 1986 and, except for incidental items, ceased in October 1987. Expenditures for research and development, including work performed by independent contractors was $116,950 in 1997 and $25,000 in 1996. General and administrative were $633,187 in 1997 as compared with $1,291,082 in 1996. These expenses include professional fees, payroll, insurance costs and travel expenses. Notes payable in 1997 of $354,115 and 1996 of $332,315 have interest accruing at rates averaging from 6.07% to 8%. Years Ended December 31, 1996, and December 31, 1995 There were no sales during either year. Sales commenced in May 1986 and, except for incidental items, ceased in October 1987. Expenditures for research and development including work performed by independent contractors were $25,000 in 1996. There were no such expenditures in 1995. General and administrative expenses were $1,291,082 in 1996 as compared to $1,170,119 in 1995. These expenses include professional fees, payroll, insurance costs and travel expenses. Notes payable in 1996 of $332,315 and $147,815 in 1995 have interest accruing at rates ranging from 8% to 10%. Liquidity and Capital Resources At December 31, 1997, the Registrant had a working capital deficiency of $945,859 and a stockholders' deficiency of $886,167. At December 31, 1996, Registrant had a working capital deficiency of $949,254 and a stockholders' deficiency of $885,241. -14- During 1987, excluding options exercised and shares issued for services, Registrant sold an aggregate of 950,000 shares to unrelated individuals at prices ranging from $.10 to $.25 for aggregate proceeds of $150,000 and borrowed $150,000 which, in 1989, was exchanged for 1,500,000 shares. During 1988, excluding options exercised and shares issued for services, Registrant sold 1,000,000 shares to an unrelated individual at $.08 per share, and borrowed an aggregate of $166,700 which, in 1989, was exchanged for 1,834,000 shares. During 1989, excluding options exercised and other issuances not for cash, Registrant sold an aggregate of 5,790,000 shares to unrelated individuals at prices ranging from $.03-1/3 to $.10 per share, for aggregate proceeds of $291,500. During 1990, excluding issuances to settle outstanding obligations and for services, Registrant sold an aggregate of 4,250,000 shares to unrelated individuals at prices ranging from $.03 to $.05 per share for aggregate proceeds of $179,500. During 1991, excluding options exercised and issuances for services, Registrant sold an aggregate of 4,366,667 shares to unrelated individuals at prices ranging from $.036 to $.20 per share, for aggregate proceeds of $310,000. During 1992, excluding options exercised and issuance of shares for services, Registrant sold an aggregate of 2,702,335 shares to unrelated individuals at prices ranging from $.15 to $.20 per share for aggregate proceeds of $430,350. During 1993, excluding issuance of shares for services, Registrant sold an aggregate of 1,471,766 shares to unrelated individuals at prices ranging from $.15 to $.20 per share for aggregate proceeds of $271,000. Registrant also received proceeds from stock subscriptions totaling $261,915. During 1994, excluding issuance of shares for services, Registrant sold an aggregate of 9,552,340 shares to unrelated individuals at $.10 per share for aggregate proceeds of $955 234. During 1995, excluding issuance of shares for services, Registrant sold an aggregate of 8,984,450 shares to unrelated individuals at $.10 per share for aggregate proceeds of $898,445. During 1996, excluding issuance of shares for services, Registrant sold an aggregate of 7,254,470 shares to unrelated individuals at $.10 per share for aggregate proceeds of $725,447. During 1997, excluding issuance of shares for services, Registrant sold 5,714,285 shares to The Sand Dollar Solution, a California limited partnership, and an affiliate of the Registrant, at $.07 a share for aggregate proceeds of $400,000. In connection with certain of the foregoing transactions, the Company has paid or accrued finders' fees. Registrant will continue to require additional funding to enable it to fund research necessary to make the appropriate regulatory application and continue operations. Item 8. Financial Statements and Supplementary Data. ------------------------------------------- The financial statements and supplementary data are listed under Item 14 in this Annual Report and commence on page F-1. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. --------------------------------------------- None. -15- PART III Item 10. Directors and Executive Officers of Registrant. ---------------------------------------------- On July 7, 1996, at the Company's annual meeting, Joseph S. Latino, George Handel, Kenneth Gropper, John D. Pealor and Richard G. Solomon were elected to the Company's Board of Directors. On July 31, 1996, Lawrence I. Sosnow and Howard L. Feinsand were appointed to the Company's Board of Directors. Mr. Sosnow resigned and Mr. Feinsand resigned as Directors on October 1, 1996 and March 26, 1997, respectively. Richard G. Solomon resigned as a Director on February 27, 1997. On May 14, 1997, the Company's Board of Directors terminated the employment of Joseph L. Latino ("Latino") as the Company's President and Chairman after the discovery of a pattern of unaccounted for expenditures of the Company's funds. The Company is investigating the purposes, nature and extent of such expenditures. Dr. Latino remained a Director of the Company until he resigned in August 1997. George Handel ("Handel") was named President and Chairman and served as such until May 19, 1997 when Kenneth Gropper ("Gropper") assumed these positions. Contemporaneously with the above events, the Company was notified that The Sand Dollar Solution, a California limited partnership ("Sand Dollar"), whose general partner is Edwin G. Marshall ("Marshall"), was soliciting shareholder proxies to vote for Marshall, Milton G. Adair ("Adair"), Gerard V. Sunnen, M.D. ("Sunnen") and William M. Hitt, Ph.D., M.D. ("Hitt") as Directors. On June 12, 1997, the Company's Board of Directors appointed Marshall, Adair, Sunnen and Hitt, to the Registrant's Board of Directors, with Marshall being named Chairman. Contemporaneously thereto, John Pealer ("Pealer") resigned as a Director, and Gropper resigned as President. The Board thereupon made the following appointments to the following positions: President and - Adair Chief Executive Officer Chief Operating Officer - Gropper Secretary - Sunnen The Board also named an Executive Committee, composed of Marshall, Adair, Gropper, Sunnen and Hitt. The remaining Directors were Latino and Handel; however, during the Board meeting, Handel resigned from the Board, effective June 13, 1997 and Latino subsequently resigned from the Board in August 1997. The Board abolished the position of Chief Executive Officer - Administration, which had been established on April 30, 1997. The holder of the position, Arthur P. Bergeron, remains Vice President, Treasurer and Chief Financial Officer of the Registrant. In November 1997, the Board abolished the position of Chief Operating Officer, held by Gropper, who remains a Director. The following table sets forth certain information concerning the Registrant's directors and officers, as of December 31, 1997. Director Officer Positions with Name Age Since Since Registrant - ---- --- -------- ------- -------------- Edwin G. Marshall 55 1997 Chairman of the Board Milton G. Adair 65 1997 1997 President, Chief Executive Officer and Director Gerard V. Sunnen 55 1997 1997 Secretary and Director -16- Arthur P. Bergeron 47 1992 Vice President, Chief Financial Officer William M. Hitt 71 1997 Director Kenneth Gropper 55 1995 Director Edwin G. Marshall became the Company's Chairman in June 1997. He attended Santa Rosa Junior College and the College of Marin, in California, studying Business and Fire Science. Marshall served for 17 years in the fire service, rising to become Captain of the Richmond, California Fire Department. He left the fire service in 1979 to enter the real estate business. He participated in the real estate business as the owner of Smith, Smith & Associates, in Truckee, California, from 1979 to 1984, and as a broker with TRI Realtors, in the San Francisco Bay Area, from 1987 to 1990. Marshall was employed by Future Technology Marketing, Inc., of Truckee, California, in sales and training from 1985 to 1987. In 1989, Marshall co-founded The Marin Car Company, which was in the automobile and truck sales and leasing business, in Novato and Petaluma, California. In 1992, Marshall left The Marin Car Company. He is currently employed as a private investor and is also the general partner of Sand Dollar. Milton G. Adair became the Company's President, Chief Executive Officer and a Director in June 1997. He received a Bachelor of Arts degree in Business Administration and Psychology from The College of the Pacific in 1955. After employment by Shell Oil Company and Pittsburgh Des Moines Steel from 1955 to 1963, Mr. Adair was employed by Pfizer Incorporated from 1963 to 1978 in several capacities, culminating in his position as Director of Sales for the Pfizer Diagnostics division. From 1978 to 1979, Mr. Adair was employed as Vice President-Sales/Marketing for the Becton Dickinson Immunodiagnostics division of Becton Dickinson Corporation ("BD") in Orangeburg, New York. Thereafter, until 1983, he was Vice-President and General Manager of Becton Dickinson Automated Immunochemistry division of BD in Salt Late City, Utah. From 1983 to 1984, Mr. Adair was President of Orbit Medical Systems, Inc., a Salt Lake City venture capital company in the immunochemistry field. Mr. Adair was President, Chief Executive Officer and a Director of Mountain Medical Equipment, Inc., in Littleton, Colorado, whose stock was traded on the American Trade Exchange (the "AMEX"), from 1984 to 1991. In 1991, he became President and Chief Executive Officer of Gull Laboratories, Inc. ("Gull Labs"), in Salt Lake, and whose stock trades on the AMEX, and which is in the business of supplying diagnostic kits and automated equipment in the infectious disease and autoimmune markets. He remained at Gull Labs until 1995 and became President and Director of Biomune Systems, Inc. ("Biomune") until 1997. Biomune, whose stock is traded on the NASDAC system, is a bio-technology company that is developing pharmaceutical products for the treatment of cryptosporidioses and E. Coli. Gerard V. Sunnen, M.D. became Secretary and a Director of the Company in June 1997. He graduated from Rutgers University in 1963 and from the medical school of the State University of New York, Downstate, in 1967. Dr. Sunnen has practiced psychiatric medicine since his graduation from medical school and has taught clinical psychiatry at New York University Medical Center since 1977, where he is now an Associate Clinical Professor of Psychiatry. He is currently a consultant to several organizations and companies, including the Institute for Behavior Therapy and the Training Institute for Mental Health Practitioners in New York. He is a member of the American Psychiatric Association, the American Society of Clinical Hypnosis, the International Association of Emergency Psychiatry, of which he is Honorary President, and the World Psychiatric Association, where he is currently Vice President of the Section for Emergency Psychiatry. He received the Chevalier de l'Ordre du Merite from the French government in 1990 for his work in assisting members of the French community in New York. Dr. Sunnen has written and lectured extensively on psychiatric medicine and medical hypnosis. He have also written on the medical applications of ozone. -17- William M. Hitt became a Director of the Company in June 1997. He received a Bachelor's of Science degree from the University of Denver in 1946 and a Ph.D. from Colorado A&M University in 1948. He received a medical degree from the University of Colorado in 1952 and did post-medical school studies at Duke University and Washington University School of Medicine. Dr. Hitt has taught and conducted research at several institutions in the United States and Mexico, culminating with his work at the World Health Organization in Mexico City from 1989 to 1994. He was the recipient of the Eli Lily Award from the National Institute of Health in 1953; the Leovenhoek Award in 1960, the Cientifico Destacado in 1990 and 1992, and the Bioethics International Award of Merit in 1993. Dr. Hitt was a member of the Board of Directors of Physicians Against Nuclear War, which organization was awarded the Nobel Peace Prize in 1985. Dr. Hitt is currently the Director of the William Hitt Center, which conducts clinical immunology and addiction recovery programs, has operated since 1986 and now has seven locations in Central and South America, with headquarters in Tijuana, Mexico. Kenneth Gropper became a director of the Company in September 1995. Mr. Gropper is the President and Chief Executive Officer of Management Consulting Group, Inc. of Woburn, Massachusetts, which serves as a consultant to physician group practices, medical centers, pharmaceutical companies and medical device manufacturers on regulatory, legislative, administrative, sales, marketing and other management issues. Mr. Gropper joined Management Consulting Group, Inc. in 1977. Mr. Gropper was a member of the Board of Trustees of the Massachusetts Eye and Ear Infirmary from 1989 to 1994. Mr. Gropper received a Bachelor of Arts degree in Economics from Long Island University in 1964 and attended Columbia University's Graduate School of Business Administration. Arthur P. Bergeron became Vice President, Treasurer and Chief Financial Officer of the Company in 1992. He holds these same positions with MCL. He received a Bachelor of Science in Accounting from Bentley College in Waltham, Massachusetts in 1973 and a Master of Science in Taxation from Bentley College in 1980. Mr. Bergeron is a certified public accountant and is the principal of Arthur P. Bergeron & Co., P.C., in Wellesley, Massachusetts, a public accounting firm which he founded in 1978. He does not devote his full time to the affairs of the Company. Item 11. Executive Compensation. ---------------------- Directors Compensation None of the directors received any compensation for serving as a director in 1997. Executive Compensation The following table sets forth the compensation paid by the Company for the 1995, 1996 fiscal years to Joseph S. Latino, the Company's President and Chief Executive Officer, in 1997 to Milton G. Adair, the Company's President and Chief Executive Officer, and to Arthur Bergeron, the Company's Vice President, Treasurer and Chief Financial Officer, and to certain others who served as officers during these periods. Summary Compensation Table -------------------------- Long Term Annual Compensation Compensation ------------------- ------------ Name and Other Principal Annual Position Year Salary Bonus Compensation Options # - -------- ---- ------ ----- ------------ --------- -18- Joseph S. Latino, Ph.D, Pres- 1996 $180,000 - 0 - (1) ident and Chief Executive 1995 $180,000 - 0 - (1) 3,000,000 Officer Milton G. Adair, 1997 $200,000 - 0 - - 0 - 3,000,0002 President and Chief Executive Officer Arthur P. Bergeron, Vice 1997 $72,000(3) - 0 - (4) President, Treasurer and 1996 $72,000(3) - 0 - 1,500,000 Chief Financial Officer 1995 $72,000 - 0 - Dr. Gerard V. Sunnen, 1997 - 0 - - 0 - (5) Secretary, and Director of Science Kenneth Gropper, Chief 1997 - 0 - - 0 - (6) Operating Officer George Handel 1997 -0- - 0 - (7) Secretary Employment Agreements - ------------------------------- (1) In 1995 and 1996 Dr. Latino was reimbursed for certain automobile expenses and other business expenses, in the amounts of $33,222 and $45,642 respectively. In 1995 and 1996 the Company provided Dr. Latino with health insurance, paying premiums in the amounts of $9,438 and $10,380, respectively. (2) On December 16, 1997, Mr. Adair was granted options to purchase 3,000,000 shares of the Company's Common Stock pursuant to the Company's 1997 Qualified Stock Option Plan (the "Option Plan"). The options vest at the rate of 500,00 shares every six months and, once vested, may be exercised over a period of ten years at a price equal to the Common Stock's market value at the date of grant ($.06). The Option Plan will be submitted to a shareholder vote at the Company's 1997 annual meeting.6 (3) In 1996, due to the Company's financial condition, Mr. Bergeron received only $36,000 to his salary. He has not received payment of his salary in 1997. (4) In 1995, 1996 and 1997 the Company provided Mr. Bergeron with health insurance, paying premiums in the respective amounts of $9,438, $10,380 and $2,595 (until April 18, 1997, when the Company's group health plan was cancelled). (5) Dr. Sunnen received a grant of (i) options to purchase 300,000 shares of the Company's common stock pursuant to the Option Plan for serving as the Company's Secretary and as its Director of Science; and (ii) 100,000 shares of the Company's common stock for serving as Director of Science. (6) Mr. Groper received an award of 500,000 shares of the Company's Common Stock and a grant of an option to purchase 100,000 shares of the Company's Common Stock pursuant to the Option Plan for serving as the Company's Chief Operating Officer during part of 1997. (7) George Handel received an income of 750,000 shares by the Company's Common Stock for serving as the Company's Secretary in 1994, 1995 and 1996. -19- The Company and Joseph S. Latino entered into an employment agreement, effective January 1, 1995, pursuant to which the Company agreed to employ Dr. Latino as its Chief Executive Officer and Director of Research, at a salary of $180,000 per annum, for a one year period; provided, however, that this agreement shall remain in effect until terminated by either of the parties in accordance with its terms. Dr. Latino received certain fringe benefits, including the use of an automobile and health and life insurance and was been granted an option to purchase 3,000,000 shares of the Company's common stock, par value $.001, at a per share price of $.20. These options vested in annual increments of 1,000,000 shares, on and after January 1 of each of 1996, 1997 and 1998, provided that Dr. Latino is still employed by the Company at the time. The Agreement continued in effect in 1996 but was terminated for cause in May 1997. The Company agreed to employ Arthur P. Bergeron, effective January 1, 1995, as its Chief Financial Officer, at a salary of $72,000 per annum, plus monthly expenses, for a one year period; provided, however, that this agreement shall remain in effect until terminated by either party in accordance with its terms. The Agreement continued in effect in 1996 and 1997. Mr. Bergeron's salary may be increased in the discretion of the Board of Directors. Mr. Bergeron is also to serve as the Chief Financial Officer of Medizone Canada Limited without additional compensation. Pursuant to this agreement, Mr. Bergeron is permitted to continue his private accounting practice. Mr. Bergeron will also receive health insurance from the Company and has been granted an option to purchase 1,500,000 shares of the Company's common stock, par value $.001, at a per share price of $.20. These options vest in annual increments of 500,000 shares on and after January 1 of each of 1996, 1997 and 1998, provided that Mr. Bergeron is still employed by the Company at that time. The agreement also provides for certain bonuses to be paid if the Company achieves certain financial results. The Company does not have a written employment agreement with Milton G. Adair. Compensation Committee Interlocks and Insider Participation The Company does not have a compensation committee. Matters concerning the compensation of executive officers are determined by the Company's Board of Directors. Until his termination, Dr. Latino, who was an executive officer of the Company, was also a member of the Company's Board of Directors and participated in deliberations concerning executive officer compensation, but did not vote on his own individual compensation. However, his participation in such deliberations gave rise to a conflict of interest which could have affected his compensation. Mr. Adair, who is an executive officer of the Company is also a member of the Company's Board of Directors and will participate in deliberations concerning executive offer compensation, but will not vote in his own individual compensation. However, his participation in such deliberations gives rise to a conflict of interest which could affect his compensation. Option Grants in Last Year Pursuant to Employment Agreement ----------------------------------------------------------- The following table sets forth information as of December 31, 1997 regarding the outstanding options under the Company's employment agreements with its executive officers.
Potential realizable value at Assumed Annual Rates of Stock Price Appreciation for Option. Percent of Total Options granted Number of under Securities Under Employment Exercise Expiration Name Option(1) Agreements Price ($/sh) Date 5%($) 10%($) - ---- ------ ---------- ------------ ---- ----- ------ Joseph S. 3,000,000 66.66% $.20 (1) (1) (1) Latino Arthur P. 1,500,000 33.33% $.20 (1) (1) (1) Bergeron
-20- (1) Options were granted on January 1, 1995 pursuant to the Company's employment agreements with each of Dr. Latino (options for 3,000,000 shares) and Mr. Bergeron (options for 1,500,000 shares). The exercise price of the option is $.20. They vest fully on January 1, 1998 over the following vesting schedule, 33% on January 1, 1996, 33% on January 1, 1997 and 33% on January 1, 1998. They may be exercised for as long as Dr. Latino and Mr. Bergeron remain employed by the Company and for one year after the termination of Dr. Latino's and/or Mr. Bergeron's employment with the Company. As of January 1, 1995 (the date of grant), the average of the high and low bid price for the Company's common stock was approximately $.14. As of March , 1998, the average of the high and low bid price for the Company's common stock was approximately $. . Aggregate Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values --------------------------------- The following table provides information on the value of the Company's named executive officers' unexercised options to purchase shares of the Company's common stock as of December 31, 1997.
Number of Unexercised Value of Unexercised Options at December 31, in-the-money option at 1997 December 31, 1997 ($)(1) Shares Unex- Acquired on Value Exer- Unexer- Exerci- erci- Name Exercise Realized cisable cisable sable sable - ---- ----------- -------- ------- ------- ------- ------ Joseph S. Latino(2) -0- -0- 2,000,000 1,000,000 -0- -0- Arthur P. Bergeron -0- -0- 1,000,000 500,000 -0- -0-
(1) Fiscal year ended December 31, 1997. The average high and low bid of the Company's common stock at March __, 1998 was $_____. (2) Dr. Latino was terminated for cause on May 14, 1997. BOARD OF DIRECTORS ------------------ Edwin G. Marshall Milton Adair Dr. Gerard V. Sunnen Dr. William M. Hitt Kenneth Gropper Mr. Adair, an executive officer is a member of the Board of Directors and participates in deliberations concerning executive officer compensation, but does not vote on his own individual compensation. However, his participation in these deliberations may give rise to a conflict of interest. -21- Item 12. Security Ownership of Certain Beneficial Owners and Management. --------------------------------------------------------------- The following table sets forth certain information as of January 8, 1998, pertaining to the beneficial ownership of Common Stock, by (i) persons known to the Company to own 5% or more of the outstanding Common Stock, (ii) each director and executive officer of the Company as of December 31, 1996 and December 31, 1997, and (iii) present directors and executive officers of the Company as a group. Number of Shares Percentage of Name and Address Beneficially Owned Total Outstanding - ---------------- ------------------ ----------------- Arthur P. Bergeron 3,830,334(1) 2.76% 40 Grove Street Wellesley, MA 02181 Kenneth Gropper 660,0002 0.48% 129 Eagle's Nest Road Lincoln, NH 03251 Edwin G. Marshall 74,098,3333 36.08% P.O. Box 342 Stinson Beach, CA 94970 Milton G. Adair - 0 -(4) - 0 - 2401 SouthFoot Hill Drive Salt Lake City, Utah 04109 Dr. Gerard V. Sunnen 1,500,0005 1.08% 200 East 23rd Street New York, NY 10016 - ------------------ (1) Includes (i) 544,167 shares held through the Bergeron Profit Sharing Plan; and (ii) 1,000,000 shares obtainable upon exercise of the option granted in Mr. Bergeron's employment agreement which vested on January 1, 1996 (500,000 shares) and January 1, 1997 (500,000 shares). (2) Includes 500,000 shares registered in the name of his wife, but excludes options to purchase 100,000 shares of the Company's Common Stock granted pursuant to the Company's Option Plan which will be cancelled if the plan is not approved by the Company's shareholders. (3) Includes: (i) an aggregate of 351,000 shares owned by Mr. Marshall's wife, son and mother; (ii) 6,571,428 shares owned by Sand Dollar, of which Mr. Marshall is the general partner; and (iii) options to purchase 66,761,905 shares owned by Sand Dollar. (4) Does not include options to purchase 3,000,000 shares of the Company's common stock granted pursuant to the Company's Option Plan, which will be cancelled if the Option Plan is not approved by the shareholders. (5) Includes 100,000 shares awarded as compensation for serving as Director of Science which were unissued at December 31, 1997, but does not include options to purchase 300,000 shares of the Company's common stock granted pursuant to the Company's Option Plan, which will be cancelled if the Option Plan is not approved by the shareholders. -22- Number of Shares Percentage of Name and Address Beneficially Owned Total Outstanding - ---------------- ------------------ ----------------- Dr. William M. Hitt - 0 - - 0 - 4248 Palm Avenue San Diego, CA 92154 All present directors 80,088,667 38.97% and executive officers as a group (6 persons) Item 13. Certain Relationships and Related Transactions. ----------------------------------------------- Loans from Directors On August 22, 1994, the Company borrowed $18,000 from George Handel and $10,000 from John Pealer, two of the Company's directors, and $9,000 from Samuel Handel, the brother of George Handel. Each of these loans was payable on August 23, 1995 and bears interest at an annual rate of 8%, payable on the maturity of the loans. The maturity date on these loans has been extended to August 23, 1997. Each of the lenders has the right to require that payment of principal and interest due on his loan be made in shares of the Company's common stock, at a per share price equal to that charged by the Company in the most recent private transaction prior to the maturity of the loans. On June 4 and June 8, 1995, the Company borrowed $25,000 from George Handel and $25,000 from Samuel Handel, respectively, payable in June 1996, which date has been extended to June 1997. These loans bear interest at an annual rate of 9% and have the same conversion terms as the 1994 loans from these individuals. In February 1996, the Company borrowed $25,000 from Richard G. Solomon, $12,000 from George Handel and $10,000 from John Pealer, three of the Company's directors. These loans were payable on June 15, 1996, but payment was thereafter extended to June 15, 1997. In August 1996, the Company borrowed $32,500 from George Handel, $15,000 from Samuel Handel and $10,000 from Richard Solomon, payable in one year. In September 1996, the Company borrowed $10,000 from Howard Feinsand, at the time a director, payable in ninety days. In November 1996, the Company borrowed $10,000 from each of John Pealer, George Handel and Richard Solomon, payable in November 1997. The 1996 loans bear interest at an annual rate of 8%, payable on the maturity of the loan. The Company has the right to make payments of principal and interest on these loans in shares of the Company's common stock, at a per share price equal to that charged by the Company in its most recent private transaction prior to the maturity of the loan. On or about January 31, 1997, the Company borrowed $1,800 from George Handel. The loan bears interest at 8% per annum and is payable in one year and has the same conversion terms as the 1996 loans. In June 1997, in connection with their appointment to the Board, Messrs. Marshall, Adair, Sunnen and Hitt (collectively, the "New Directors") and Sand Dollar entered into an agreement in principal (the "Agreement") with Messrs. Gropper, Handel and Pealer (collectively, the "Old Directors") pursuant to which the parties agreed, inter alia, (a) that Messrs. Pealer and Handel resign as Directors; (b) to cause the election of the New Directors to the Registrant's Board of Directors and to cause the appointment of Mr. Marshall as Chairman, Mr. Adair as President, Mr. Gropper as Chief Operating Officer and Dr. Sunnen as Secretary; -23- (c) to cause the Registrant to enter into indemnification agreements with each of the New Directors and Old Directors; (d) that the New Directors shall not commence or participate in any legal proceedings, including class actions, against the Old Directors arising out of the operations of the Registrant; (e) to release and hold each other harmless against any claim or liability of any kind (with the exception of any obligations under the Agreement); and (f) to cause the issuance to Sand Dollar of warrants to purchase an aggregate of 73,333,333 shares of the Registrant's common stock as described above. Issuance of Securities In May 1997, the Company issued 500,000 shares of the Company's common stock to each of Arthur P. Bergeron and Kenneth Gropper in consideration of their services as officers of the Company and 750,000 to George Handel in consideration of his services as the Company's Secretary. In December 1997, the Company awarded Dr. Gerard Sunnen 100,000 shares of common stock in consideration of his services as the Company's Director of Science. In December 1997, the Board of Directors voted to establish the Option Plan, which is to be submitted for shareholders approval at the 1997 annual meeting. Pursuant to the Option Plan, options to purchase shares of the Company's common stock were granted to Milton G. Adair (3,000,000 shares), Gerard V. Sunnen (300,000 shares) and Kenneth Gropper (100,000), which grants will be cancelled if the Option Plan is not approved by the shareholders. On September 23, 1997, Sand Dollar purchased 5,714,285 shares of the Company's common stock pursuant to the Sand Dollar Warrant, at a per share price of $.07, an aggregate of $400,000. On March ___, 1998, Sand Dollar purchased an additional 857,143 shares for $60,000. -24- PART IV Item 14. Exhibits, Financial Statement Schedules, Reports on Form 8-K ---------------------------------------- (a) See Index to Consolidated Financial Statements and Schedules on Page F-1. (b) See Index to Exhibits on page E-1. (c) None. SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized. MEDIZONE INTERNATIONAL, INC. By: s\Milton G. Adair ------------------------------------- Milton G. Adair President and Chief Executive Officer Date: January 28, 1998 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the Company, in the capacities shown and on the date indicated: Date: March 30, 1998 s/Milton G. Adair ------------------------------------ Milton G. Adair, President Chief Executive Officer and Director Date: March 30, 1998 s/Arthur P. Bergeron ------------------------------------ Arthur P. Bergeron, Vice President, Treasurer and Chief Financial Officer Date: March 30, 1998 s/Edwin G. Marshall ------------------------------------ Edwin G. Marshall, Director Date: March 30, 1998 s/Gerard V. Sunnen ------------------------------------ Gerard V. Sunnen, Director Date: March 30, 1998 s/Kenneth Gropper ------------------------------------ Kenneth Gropper, Director Date: March 30, 1998 s/William M. Hitt ------------------------------------ William M. Hitt, Director -25- Exhibits and Financial Statement Schedules. The following Exhibits form a part of this Annual Report on Form 10-K. Exhibit Number Description of Exhibit - ------ ---------------------- 2 Agreement and Plan of Reorganization dated March 12, 1986.(2) 3(a) Articles of Incorporation of Registrant.(2) 3(b) By-laws of Registrant.(2) 3(c) Articles of Amendment to Registrant's Articles of Incorporation.(3) 10(a) Patent Agreement, dated February 26, 1987. 10(b) Assignment of Distributor Agreement by Terrence O. McGrath to Medizone Delaware, dated February 4, 1986, and Distributor Agreement between Terrence O. McGrath and Dr. J. Hansler GmbH, dated September 25, 1985.(3) 10(c) Letter confirmation and Protocol, dated June 2, 1986, by Registrant with regard to research to be conducted by the State University of New York at Syracuse.(2) 10(d) Consulting Agreement between P.J. Watrous & Co., Inc. and the Registrant.(2) 10(f) Consulting Agreement between Jeffrey Freed, MD, PC and the Registrant.(2) 10(g) Consulting Agreement between Joseph Latino, PhD and the Registrant.(2) 10(h) Consulting Agreement between Susan Golden, RN and the Registrant.(2) 10(i) Stock Option of Joseph Latino.(2) 10(j) Stock Option of Jeffrey Freed.(2) 10(k) Stock Option of Susan Golden.(2) 10(l) Stock Option of Hubert Weinberg.(2) 10(m) Agreement dated June 16, 1987, between Registrant and Oliver Grace.(5) 10(n) Agreement dated June 26, 1987, between Registrant and John Grace.(5) 10(o) Agreement dated June 26, 1987, between Registrant and Oliver Grace.(5) 10(p) Agreement dated June 30, 1987, by and among Registrant and John C. Black, Dr. Gerard V. Sunnen and Dr. Priyakant S. Doshi.(5) 10(q) License Agreement with MCL Medizone Canada Ltd. dated November 18, 1987.(5) 10(r) Agreement dated October 1988 by and among Immunologics, Limited Partnership, John M. Kells, Y. C. Zee, David C. Bolton and Medizone International, Inc.(6) 10(s) Form of Stock Purchase Agreement between Registrant and individuals who purchased Shares from Registrant.(7) 10(t) Letter agreement between Registrant and Rebus Oil Co., Ltd. dated July 28, 1992.(8) 10(u) Letter of understanding between Registrant and the RMB Group of Boston dated August 10, 1992.(8) E-1 10(v) Agreement between Registrant and Rebus Oil Company, Ltd., dated as of October 20, 1992.(9) 10(w) Letter agreement among Messrs. McGrath, Watrous, Melera, Chou, Kells, Handel and Pealer, dated as of November 10, 1992.(9) 10(x) Loan agreement with Messrs. McGrath and Watrous dated as of November 16, 1992.(9) 10(y) Settlement agreement with former consultant dated February 12, 1993.(9) 10(z) Consulting Agreement with Joseph S. Latino dated as of January 1, 1993.(9) 10(aa) Consulting Agreement with Arthur P. Bergeron dated as of January 1, 1993.(9) 10(bb) Employment Agreement with Katherine M. Kalinowski dated as of January 1, 1993.(9) 10(cc) Consulting Agreement with Roger Shelley dated as of January 1, 1993.(9) 10(dd) Consulting Agreement with Jeannette Arsenault dated as of January 1, 1993.(9) 10(ee) Loan Agreements between Registrant and John Kells, George Handel and John Pealer, executed as of June 11, 1993 (and promissory notes).(9) 10(ff) Promissory Note to Joseph S. Latino dated as of October 26, 1993 and Acceptance Form dated as of November 26, 1993.(9) 10(gg) Letter Agreement dated March 23, 1993 between Registrant and the Italian Scientific Society.(10) 10(hh) Contract between Registrant and Capmed USA.(10) 10(ii) Agreement made as of May 18, 1994, among Medizone International, Inc., Medizone Canada Ltd., John M. Kells, George Handel, John Pealer, Joseph S. Latino, Terrence O. McGrath and Philip J. Watrous.(11) 10(jj) Agreement made as of January 1, 1995, between Medizone International, Inc. and Joseph S. Latino.(11) 10(kk) Agreement made as of January 1, 1995 between Medizone International, Inc. and Arthur P. Bergeron.(11) 10(ll) Agreement made as of January 1, 1995 between Medizone International, Inc. and Giacomo C. DiGiorgio, M.D.(11) 10(mm) Lease Agreement between Medizone International, Inc. and Benabi Realty, made on September 27, 1991, as extended, January 17, 1995.(11) 10(nn) Agreement for Sale and Purchase of Shares in Medizone New Zealand Limited between Richard G. Solomon and Medizone International, Inc., dated June 22, 1995.(12) 10(oo) Shareholders' Agreement relating to Medizone New Zealand Limited between and among Solwin Investments Limited, Medizone International, Inc. and Medizone New Zealand Limited, dated June 22, 1995.(12) 10(pp) Licensing Agreement between Medizone International, Inc. and Medizone New Zealand Limited, dated June 22, 1995.(12) 10(qq) Managing Agent Agreement between Medizone International, Inc. and Medizone New Zealand Limited, dated June 22, 1995.(12) 10(rr) Lease Agreement between Medizone International, Inc. and Linmar L.P., dated January 17, 1996.(13) E-2 10(ss) Agreement between Medizone International, Inc. and Multiossigen S.r.l., dated as of September 13, 1996.(14) 10(tt) Agreement between Medizone International, Inc. and JRH Biosciences, Inc., dated April 17, 1997.(15) 10(uu) Lease Agreement between Medizone International Inc. and Eagle Overlook, L.C., made on September 23, 1997.(16) 16 Letters re: change in certifying accountants.(11) - -------------------- (1) Filed herewith. (2) Incorporated by reference to the Registrant's registration statement on Form S-18 (Registration No. 2-93277-D), effective May 14, 1985. (3) Incorporated by reference to the Registrant's annual report on Form 10-K for the period ended December 31, 1986. (4) Incorporated by reference to the Registrant's current report on Form 8-K, filed March 13, 1987. (5) Incorporated by reference to the Registrant's annual report on Form 10-K for the period ended December 31, 1987. (6) Incorporated by reference to the Registrant's annual report on Form 10-K for the period ended December 31, 1988. (7) Incorporated by reference to the Registrant's annual report on Form 10-K for the period ended December 31, 1989. (8) Incorporated by reference to the Registrant's annual report on Form 10-K for the period ended December 31, 1990. (9) Incorporated by reference to the Registrant's annual report on Form 10-K for the period ended December 31, 1992. (10) Incorporated by reference to the Registrant's current annual report on Form 8-K dated September 8, 1993. (11) Incorporated by reference to the Registrant's annual report on Form 10-K for the period ended December 31, 1994. (12) Incorporated by reference to the Registrant's current annual report on Form 8-K, dated June 22, 1995. (13) Incorporated by reference to the Registrant's annual report on Form 10-K for the period ended December 31, 1995. (14) Incorporated by reference to the Registrant's current report on Form 8-K, dated October 17, 1996. (15) Incorporated by reference to the Registrant's current report on Form 8-K, dated May 5, 1997. (16) Incorporated by reference to the Registrant's current report on Form 8-K dated September 24, 1997. E-3 MEDIZONE INTERNATIONAL, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Andersen, Andersen & Strong, Independent Certified Public Accountants.................................................F-2 Consolidated Balance Sheets..................................................F-3 Consolidated Statements of Operations........................................F-4 Consolidated Statements of Changes in Stockholders' Equity...................F-5 Consolidated Statements of Cash Flows.......................................F-12 Notes to Consolidated Financial Statements..................................F-14 INDEX TO SCHEDULES None Required F-1 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors and Stockholders Medizone International, Inc. We have audited the consolidated balance sheets of Medizone International, Inc. and subsidiaries (a development stage company) as of December 31, 1997 and 1996, and the related statements of operations, stockholders' equity and cash flows for the years ended December 31, 1997, 1996 and 1995, and the period January 31, 1986 (date of inception) through December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Medizone International, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for the years ended December 31, 1997, 1996 and 1995, and the period January 31, 1986 (date of inception) through December 31, 1997, in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 3. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Salt Lake City, Utah March 19, 1998 F-2 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) CONSOLIDATED BALANCE SHEETS December 31, 1997 and 1996 ASSETS
1997 1996 ------ ------ CURRENT ASSETS Cash and cash equivalents $ 138,173 $ 3,579 Prepaid expenses and advances 9,154 6,776 ----------- ----------- Total Current Assets 147,327 10,355 ----------- ----------- FIXED ASSETS Office equipment 2,301 14,665 Furniture and fixtures 6,307 2,711 ----------- ----------- 8,608 17,376 Less accumulated depreciation (340) (8,308) ----------- ----------- 8,268 9,068 ----------- ----------- OTHER ASSETS Investment in affiliate (Note 1) -- -- Receivable from affiliate (Note 1) 48,947 48,947 License agreement (Note 5) -- -- Organization costs (net of accumulated amortization of $5,520) -- -- Deposits (Note 6) 2,477 5,998 ----------- ----------- $ 207,019 $ 74,368 =========== =========== LIABILITIES AND STOCKHOLDERS' DEFICIENCY CURRENT LIABILITIES Accounts payable $ 517,011 $ 455,885 Accrued liabilities 222,060 171,409 Notes payable (Note 10) 354,115 332,315 ----------- ----------- Total Current Liabilities 1,093,186 959,609 ----------- ----------- COMMITMENTS AND CONTINGENCIES (Notes 2, 3, 6 and 13) -- -- REDEEMABLE COMMON STOCK (Note 13) -- -- ----------- ----------- MINORITY INTEREST (Note 9) -- -- STOCKHOLDERS' DEFICIENCY (Notes 1, 2, 3, 7, 8, 9 and 11) Common stock, authorized 250,000,000 shares, par value $.001 per share; issued and outstanding 136,887,629 and 130,051,613 shares for 1997 and 1996, respectively 136,888 130,052 Common stock subscribed 5,714 3,090 Additional paid-in capital 12,188,909 11,423,736 Deficit accumulated during development stage (13,217,678) (12,442,119) ----------- ----------- Total Stockholders' Deficiency (886,167) (885,241) ----------- ----------- $ 207,019 $ 74,368 =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. F-3 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) CONSOLIDATED STATEMENTS OF OPERATIONS
From the Date of Inception (January 31, 1986) through For the Years Ended December 31, December 31, ------------------------------------------ 1997 1996 1995 1997 ------ ------ ------ ------ (restated) SALES $ -- $ -- $ -- $ 133,349 COSTS AND EXPENSES Cost of sales -- -- -- 103,790 Research and development expenses 116,950 25,000 -- 2,319,635 General and administrative expenses 633,187 1,291,082 1,170,119 9,717,721 Compensation under stock options (Note 8) -- -- -- 872,894 Interest expense 28,764 13,313 10,908 773,666 Other (income) and expense, net (3,342) -- -- (19,360) 775,559 1,329,395 1,181,027 13,768,346 Net loss before extraordinary gain and minority interest (775,559) (1,329,395) (1,181,027) (13,634,997) Extraordinary gain on sale of investment in subsidiary (Note 1) -- -- 100,000 100,000 Net loss before minority interest (775,559) (1,329,395) (1,081,027) (13,534,997) Minority interest in loss -- -- -- 26,091 Prior period adjustment (Note 11) -- -- -- 291,228 Net loss $ (775,559) $ (1,329,395) $ (1,081,027) $ (13,217,678) Weighted average number of shares outstanding 133,568,000 118,022,000 111,306,000 84,623,000 Net loss per share $ (0.01) $ (0.01) $ (0.01) (0.16)
The accompanying notes are an integral part of these consolidated financial statements. F-4 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY From the Date of Inception (January 31, 1986) through December 31, 1997
Deficit Accumulated During Common Stock Paid-in Stock Option Development -------------------- Shares Amount Subscribed Capital Compensation Stage ------ ------ ---------- ------- ------------ ----- Initial capitalization of Medizone-Delaware (no par value), February 1986, ($10.21 per share) 882 $ 9,001 $ -- $ -- $ -- $ -- Shares of Medizone-Delaware (no par value) issued for cash, March 1986 ($22.58 per share) 50 1,129 -- -- -- -- 932 $ 10,130 $ -- $ -- $ -- $ -- Medizone - Nevada (formerly Madison Funding Inc.) Existing shares of Medizone-Nevada (formerly Madison Funding, Inc.) (par value $.001 per share) 5,500,000 $ 5,500 $ -- $ 139,998 $ -- $ (310) Exchange of 932 shares of Medizone-Delaware for shares of Medizone-Nevada resulting in a reverse merger, March 1986 37,500,000 10,130 -- -- -- -- Reallocation of paid-in capital to par value due to recapitalization as a result of reverse merger -- 27,370 -- (27,370) -- -- Balance after reverse merger, March 1986 (par value $.001 per share) 43,000,000 43,000 -- 112,628 -- (310)
The accompanying notes are an integral part of these consolidated financial statements. F-5 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (Continued) From the Date of Inception (January 31, 1986) through December 31, 1997
Deficit Accumulated Additional Accrued During Common Stock Paid-in Stock Option Development -------------------- Shares Amount Subscribed Capital Compensation Stage ------ ------ ---------- ------- ------------ ----- Shares issued for services, July 1986 ($.10 per share) 50,000 $ 50 $ $ 4,950 $ -- $ -- Shares issued for warrants, August through October 1986 ($.10 per share) 7,814,600 7,815 - 773,645 -- -- Stock issuance cost in connection with shares issued for warrants -- -- - (105,312) -- -- Stock option compensation expense (Note 8) -- -- -- 223,521 -- Net loss for the year ended December 31, 1986 -- -- - -- -- (795,758) Balance, December 31, 1986 50,864,600 50,865 - 785,911 223,521 (796,068) ---------- --------- ------- --------- --------- --------- Shares issued for warrants, January 1987 ($.10 per share) 2600 2 - 257 -- -- Shares issued for patent, March 1987 ($.69375 per share) 1,000,000 1,000 - 692,750 -- -- Shares issued for cash, June 1987 (from $.10 to $.25 per share) 950,000 950 - 149,050 -- -- Shares issued for services, June and July 1987 (from $.10 to $.25 per share) 203,167 203 - 24,314 -- -- Stock option compensation expense relating to option exercised in August 1987 -- -- - -- 388,551 -- Option exercised, August 1987 ($.001 per share) 250,000 250 - 437,250 (437,250) --
The accompanying notes are an integral part of these consolidated financial statements. F-6 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (Continued) From the Date of Inception (January 31, 1986) through December 31, 1997
Deficit Accumulated Additional Accrued During Common Stock Paid-in Stock Option Development -------------------- Shares Amount Subscribed Capital Compensation Stage ------ ------ ---------- ------- ------------ ----- Adjustment to accrued stock option compensation (Note 8) $ -- $ -- $ -- $ -- $ 510,527 $ -- Net loss for the year ended December 31, 1987 -- -- -- -- -- (2,749,400) ---------- ---------- --------- ---------- ---------- ---------- Balance, December 31, 1987 53,270,367 53,270 -- 2,089,532 685,349 (3,545,468) Options exercised, January 1988 ($.001 per share) 200,000 200 -- 99,800 (99,800) -- Shares issued for cash, September 1988 ($.08 per share) 1,000,000 1,000 -- 79,000 -- -- Shares issued for services (from $.10 to $.25 per share) 35,000 35 -- 7,965 -- -- Adjustment to accrued stock option compensation (Note 8) -- -- -- -- (584,599) -- Issuances of shares by subsidiaries -- -- -- 174,126 -- -- Net loss for the year ended December 31, 1988 -- -- -- -- -- (714,347) Balance, December 31, 1988 54,505,367 54,505 -- 2,450,423 950 (4,259,815) Shares issued for services (from $.10 to $.19 per share) 261,889 262 -- 46,363 -- --
The accompanying notes are an integral part of these consolidated financial statements. F-7 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (Continued) From the Date of Inception (January 31, 1986) through December 31, 1997
Deficit Accumulated Additional Accrued During Common Stock Paid-in Stock Option Development -------------------- Shares Amount Subscribed Capital Compensation Stage ------ ------ ---------- ------- ------------ ----- Shares issued for cash (from $.03 to $.10 per share) 5,790,000 $ 5,790 $ -- $ 285,710 $ -- $ -- Shares issued for notes, accrued liabilities and services (from $.06 to $.24 per share) 4,749,532 4,750 -- 578,978 -- -- Options exercised ($.16 per share) 375,000 375 -- 59,125 (59,125) -- Adjustment to accrued stock option compensation -- -- -- -- 58,175 -- Net loss for the year ended December 31, 1989 -- -- -- -- -- (862,051) ---------- ---------- --------- ---------- ---------- ---------- Balance, December 31, 1989 65,681,788 65,682 -- 3,420,599 -- (5,121,866) Shares issued for services ($.10 share) 880,000 880 -- 87,120 -- -- Shares issued for cash (from $.03 to $.05 per share) 4,250,000 4,250 -- 175,250 -- -- Shares issued for notes and accrued liabilities (from $.055 to $.10 per share (Note 7) 2,422,727 2,423 -- 137,577 -- -- Adjustment to accrued stock option compensation -- -- -- -- 6,000 -- Issuance of shares by subsidiaries (Note 9) -- -- -- 100,000 -- Net loss for the year ended December 31, 1990 -- -- -- -- -- (606,309) ---------- ---------- --------- ---------- ---------- ---------- Balance, December 31, 1990 73,234,515 73,235 -- 3,920,546 6,000 (5,728,175) Shares issued for services (from $.15 to $.20 per share) 425,000 425 -- 72,075 -- -- Shares issued for cash (from $.036 to $.20 per share) 4,366,667 4,366 -- 305,634 -- --
The accompanying notes are an integral part of these consolidated financial statements. F-8 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (Continued) From the Date of Inception (January 31, 1986) through December 31, 1997
Deficit Accumulated Additional Accrued During Common Stock Paid-in Stock Option Development -------------------- Shares Amount Subscribed Capital Compensation Stage ------ ------ ---------- ------- ------------ ----- Options exercised (from $.22 per share to $.93 per share) 450,000 $ 450 $ -- $ 204,050 $ (204,050) $ -- Adjustment to accrued stock option compensation -- -- -- -- 324,800 -- Sale of subsidiary's stock (Note 9) -- -- -- 5,000 -- -- Net loss for the year ended December 31, 1991 -- -- -- -- -- (1,220,152) ---------- -------- -------- ---------- ---------- ---------- Balance, December 31, 1991 78,476,182 78,476 -- 4,507,305 126,750 (6,948,327) Shares issued for services ($.20 per share) 151,500 152 -- 30,148 -- -- Shares issued for accrued liabilities ($.15 per share) 250,000 250 -- 37,250 -- -- Shares issued for cash (from $.15 to $.20 per share) 2,702,335 2,702 -- 427,648 -- -- Shares in settlement of advances from and amounts due to stockholder ($.10 per share) 13,118,619 13,119 -- 800,248 -- -- Options exercised ($.50 per share) 250,000 250 -- 124,750 (124,750) -- Adjustment to accrued stock option compensation -- -- -- -- (2,000) -- Sale of subsidiary's stock (Note 9) -- -- -- 81,100 -- -- Net loss for the year ended December 31, 1992 -- -- -- -- -- (649,941) ---------- -------- -------- ---------- ---------- ---------- Balance, December 31, 1992 94,948,636 94,949 -- 6,008,449 -- (7,598,268) Cancellation of shares previously issued in settlement of advances from and amounts due to stockholder ($.062 per share) (13,118,619) (13,119) -- (800,248) -- --
The accompanying notes are an integral part of these consolidated financial statements. F-9 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (Continued) From the Date of Inception (January 31, 1986) through December 31, 1997
Deficit Accumulated Additional Accrued During Common Stock Paid-in Stock Option Development -------------------- Shares Amount Subscribed Capital Compensation Stage ------ ------ ---------- ------- ------------ ----- Shares issued for services (from $.10 to $.46 per share) 5,347,219 $ 5,347 $ -- $ 542,859 $ -- $ -- Shares issued for cash (from $.15 to $.20 per share) 1,471,666 1,472 -- 269,528 -- -- Shares subscribed ($.10 per share) -- -- 2,619 259,296 -- -- Net loss for the year ended December 31, 1993 -- -- -- -- -- (1,598,342) ---------- --------- -------- ---------- ---------- ---------- Balance, December 31, 1993 88,648,902 88,649 2,619 6,279,884 -- (9,196,610) Shares issued for services ($.10 per share) 1,431,590 1,431 -- 141,727 -- -- Shares subscribed ($.10 per share) -- -- 9,552 945,682 -- -- Shares subscribed for cancellation of indebtedness ($.10 per share) -- -- 417 41,234 -- -- Shares subscribed for cancellation of indebtedness to former management ($.18 per share) (Note 2) -- -- 11,250 2,022,379 -- -- Issuance of subscribed stock 10,384,900 10,385 (10,385) -- -- -- Issuance of shares to certain prior purchasers of common stock in recognition of disparity in purchase price in contemporaneous offering 1,125,834 1,126 -- (1,126) -- -- Prior period adjustment (Note 11) -- -- -- -- -- 219,422 Net loss for the year ended December 31, 1994 -- -- -- -- -- (1,126,315) ---------- --------- -------- ---------- ---------- ---------- Balance, December 31, 1994 101,591,226 101,591 13,453 9,429,780 -- (10,103,503)
The accompanying notes are an integral part of these financial statements. F-10 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (Continued) From the Date of Inception (January 31, 1986) through December 31, 1997
Deficit Accumulated Additional Accrued During Common Stock Paid-in Stock Option Development -------------------- Shares Amount Subscribed Capital Compensation Stage ------ ------ ---------- ------- ------------ ----- Redeemable common shares converted to common stock (Note 13) 200,000 $ 200 $ -- $ 39,800 $ -- $ -- Shares issued for services ($.10 per share) 2,050,000 2,050 -- 202,950 -- -- Issuance of subscribed stock 17,524,860 17,524 (17,524) -- -- -- Cancellation of common shares issued to former management (Note 7) (1,242,727) (1,242) -- (70,563) -- -- Shares subscribed ($.10 per share) -- -- 9,118 902,707 -- -- Prior period adjustment (Note 11) -- -- -- -- -- 71,806 Sales of stock in subsidiary (Notes 1 and 7) -- -- -- 50,000 -- -- Net loss for the year ended December 31, 1995 -- -- -- -- -- (1,081,027) ---------- --------- -------- ---------- ---------- ---------- Balance, December 31, 1995 120,123,359 120,123 5,047 10,554,674 -- (11,112,724) Shares issued for cash ($.10 per share) 100,000 100 -- 9,900 -- -- Shares issued for services ($.10 per share) 1,415,875 1,416 -- 140,171 -- -- Issuance of subscribed stock 8,412,379 8,413 (8,413) -- -- -- Shares subscribed ($.11 per share) -- -- 6,456 718,991 -- -- Net loss for the year ended December 31, 1996 -- -- -- -- -- (1,329,395) ---------- --------- -------- ---------- ---------- ---------- Balance, December 31, 1996 130,051,613 130,052 3,090 11,423,736 -- (12,442,119) Issuance of subscribed stock 3,089,680 3,090 (3,090) -- -- -- Shares subscribed ($.10 per share) -- -- 5,714 394,287 -- -- Shares issued for services ($.10 per share) 3,746,336 3,746 -- 370,886 -- -- Net loss for the year ended December 31, 1997 -- -- -- -- -- (775,559) ---------- --------- -------- ---------- ---------- ---------- Balance, December 31, 1997 136,887,629 $ 136,888 $ 5,714 $ 12,188,909 $ -- $(13,217,678) =========== ========= ======== =========== ========= ===========
The accompanying notes are an integral part of these financial statements. F-11 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) CONSOLIDATED STATEMENTS OF CASH FLOWS
From the Date of Inception (January 31, 1986) For the Years Ended December 31, through 1997 1996 1995 December 31, 1997 ---- ---- ---- ----------------- (restated) OPERATING ACTIVITIES Net loss $ (775,559) $ (1,329,395) $ (1,081,027) $(13,217,678) Prior period adjustment -- -- -- -- Adjustments to reconcile net loss to net cash used in operating activities: Issuance of stock for services 374,632 141,587 205,000 1,687,525 Subscription of stock for services -- 13,380 13,380 Compensation - stock options -- -- -- 924,975 Write-off of license agreement -- -- -- 2 Write off of patent -- -- -- 693,750 Depreciation and amortization 1,696 2,907 1,148 22,780 Minority interest in loss -- -- -- (26,091) Changes in assets and liabilities: Current and other assets (2,378) 12,655 (64,138) (58,101) Accounts payable 61,126 139,913 (115,474) 723,200 Accrued liabilities 50,651 79,423 15,338 278,845 Net Cash Used in Operating Activities (289,832) (952,910) (1,025,773) (8,957,413) INVESTMENT ACTIVITIES Additions to organization costs -- -- -- (8,904) Additions to fixed assets -- (10,002) -- (22,142) Additions to deposits 3,521 48,304 -- (2,477) Net Cash Provided by (Used in) Investment Activities 2,626 38,302 -- (33,523) FINANCING ACTIVITIES Issuance of stock for cash -- 10,000 -- 1,877,977 Stock issuance cost -- -- -- (105,312) Exercise of warrants -- -- -- 781,719 Exercise of stock options -- -- -- 1,525 Sale of stock of subsidiary -- -- 50,000 421,847 Proceeds of long-term debt -- -- -- 191,657 Proceeds of notes payable -- -- -- 283,665 Payment of notes payable -- -- -- (189,150) Redeemable common stock -- -- -- 40,000 Increase in minority interest $ -- $ -- $ -- $ 14,470
The accompanying notes are an integral part of these consolidated financial statements. F-12 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) FINANCING ACTIVITIES (continued)-
From the Date of Inception (January 31, 1986) For the Years Ended December 31, through -------------------------------- 1997 1996 1995 December 31, 1997 ---- ---- ---- ----------------- (restated) Common stock subscribed $ 400,000 $ 725,447 $ 898,445 $5,204,515 Increase in notes payable 21,800 184,500 50,000 606,196 Cash Provided by Financing Activities 421,800 919,947 998,445 9,129,109 INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 134,594 5,339 (27,328) 138,173 Cash and cash equivalents, beginning of year 3,579 (1,760) 25,568 -- Cash and cash equivalents, end of year $ 138,173 $ 3,579 $ (1,760) $ 138,173 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid for interest $ -- $ -- $ -- $ 26,483 SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES Conversion of notes payable to stock $ -- $ -- $ -- $2,091,980 Conversion of long-term debt to stock -- -- -- 191,658 Conversion of accrued liabilities to stock -- -- -- 258,689 Conversion of accounts payable to stock -- -- -- 4,285 Conversion of due to stockholders to stock -- -- -- 1,103,263 Issuance of stock for license agreement -- -- -- 2 Issuance of stock for patent -- -- -- 693,750 Cancellation of stock for reinstatement of due to stockholders -- -- -- 813,367 Conversion of redeemable common stock to common stock -- 40,000 40,000
The accompanying notes are an integral part of these consolidated financial statements. F-13 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. NATURE OF THE BUSINESS Background - ---------- Medizone International, Inc., a Delaware corporation (Medizone-Delaware) was formed on January 31, 1986. Medizone International, Inc. (the Company) was organized under the laws of the State of Nevada on August 27, 1984 as Madison Funding, Inc. (Madison) for the purposes of investing in, acquiring, operating and disposing of businesses or assets of any nature. On March 26, 1986, control of Madison was acquired by the stockholders of Medizone-Delaware, and Madison changed its name to Medizone International, Inc. The substance of this transaction was the acquisition of the net monetary assets of Madison in exchange for the equity of Medizone-Delaware. As a result of this transaction, the stockholders of Medizone-Delaware acquired 87.2% of Madison. Therefore, the transaction was accounted for as a pooling of interests. On November 18, 1987, Medizone Canada Ltd. (MedCan) was incorporated under the laws of the Province of British Columbia with authorized capital of 25,000,000 common shares without par value. Shortly thereafter, MedCan entered into a license agreement with the Company wherein the Company transferred to MedCan the licenses and rights necessary to permit MedCan to hold substantially the same rights with respect to the medical applications of ozone in Canada as the Company does in the United States. As consideration for the transfer, the Company received 3,000,000 shares of MedCan and, in addition, purchased 1 share for the sum of $1.00. Under a separate agreement among the Company, MedCan and Australian Gold Mines Corporation (AGMC), (which later changed its name to International Blue Sun Resource Corporation), a company incorporated under the laws of the Province of British Columbia, AGMC purchased 130,000 shares of MedCan for (U.S.) $100,000. On December 23, 1988, MedCan was recapitalized in a transaction in which the majority of its shares were exchanged for shares of KPC Investments, a Utah corporation (KPC). Following this transaction, the Company owned 25,029,921 shares of KPC, representing 72% of the outstanding shares. KPC then changed its named to Medizone Canada, Ltd. (MCL). MedCan acquired all of the assets of KPC, consisting solely of cash in the amount of approximately $89,000. KPC and its subsidiary MedCan are hereinafter referred to as MCL. Formation of Joint Venture Subsidiary - -------------------------------------- On June 22, 1995, Medizone International, Inc. entered into a series of contracts (collectively the "Transaction Documents") which resulted in the formation of a joint venture subsidiary incorporated in New Zealand, Medizone New Zealand Limited ("MNZ"). MNZ, a privately held corporation equally owned by the Company and Solwin Investments Limited ("Solwin"), a New Zealand corporation, was organized on June 22, 1995, and is a research and development stage company whose objective is to obtain regulatory approval for the distribution of the Company's patented technology in New Zealand, Australia, South East Asia and the South Pacific Islands. Pursuant to the Transaction Documents, the Company purchased one hundred percent of MNZ from Richard G. Soloman ("Solomon"), a New Zealand citizen, who became a director of the Company in January, 1996 and who caused the formation of MNZ on June 22, 1995. Contemporaneously with this transaction, the Company sold fifty percent of MNZ to Solwin, a corporation owned by Solomon, for U.S. $150,000, of which $50,000 was thereupon loaned by the Company to MNZ on a demand basis. The Directors of MNZ are Solomon and Milton Adair, the Company's President and Chief Executive Officer. Contemporaneous with the creation of the above share structure, the Company and MNZ entered into a Licensing Agreement (the "Licensing Agreement") and a Managing Agent Agreement (the "Managing Agent Agreement) with MNZ. F-14 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 1. NATURE OF THE BUSINESS (continued)- Formation of Joint Venture Subsidiary (continued) - ------------------------------------- Pursuant to the Licensing Agreement, the Company granted an exclusive license to MNZ for its process and equipment patents and trademark in New Zealand. MNZ has agreed to apply for corresponding patent protection for the patents in New Zealand and to use its best effort to exploit the rights granted in the agreement. The License Agreement shall terminate on the date of the expiration of the last to expire of any patent obtained in New Zealand, or, if no such patents are obtained, on June 22, 2010. The Company is to receive a guaranteed minimum royalty (the "Guaranteed Minimum Royalty") in an amount to be agreed to by the Company and MNZ, commencing in the third year after all necessary regulatory approvals requisite to the license, use or distribution of the Company's proprietary technology have been obtained in New Zealand. If the Company and MNZ are unable to agree upon the amount of the Guaranteed Minimum Royalty, the Company may terminate the license on thirty days' notice. Commencing on the first sale to a user by MNZ, the Company shall receive a sales royalty in an amount equal to ten percent of MNZ's gross annual sales under the License Agreement. Pursuant to the Managing Agent Agreement, MNZ will act as the Company's agent in the finding of other licensees of the Company's patents and trademark in the following countries: Autralasia (including Australia and New Zealand), the South Pacific Islands and South East Asia (including the Philippines, Indonesia and Vietnam). Licensing fees obtained as a result of the Managing Agent Agreement shall be divided between the Company and MNZ on a sliding scale as set forth below: Medizone Medizone New Zealand International, Inc. Limited ------------------- ----------- Initial license 50% 50% Subsequent license fees up to $500,000 50% 50% Subsequent license fees between $500,000 and $750,000 75% 25% Subsequent license fees in excess of $750,000 85% 15% MNZ and the Company will also divide any net royalties paid to the Company pursuant to any license obtained pursuant to the Managing Agent Agreement, with MNZ being paid 10% of the net royalties and the Company receiving 90% of the net royalties. The Managing Agent Agreement shall expire on the termination or expiration of the last of the licenses obtained pursuant thereto, subject to earlier termination by the Company upon an occurrence of certain events. Pursuant to Emerging Issues Task Force Statement No. 89-7, the Company recognized a $100,000 gain on the sale of MNZ to Solwin. F-15 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 1. NATURE OF THE BUSINESS (continued)- Business Activities - ------------------- The Company's objective is to gain regulatory approval for the medical uses of ozone to inactivate certain viruses and to assist in the treatment of certain diseases and to develop, promote and distribute ozone-generating equipment and related products for medical applications. By letter agreement with the Italian Scientific Society for Oxygen-Ozone Therapy (ISSOT) in Bergamo, Italy, dated March 23, 1993, the Company entered into a collaborative arrangement to research and examine the efficacy of ozone therapy and the Company's technology in the treatment of various blood-related human diseases. The research is to be conducted by ISSOT in Italy, under the direction of a research group assembled by the Italian Ministry of Health. On May 16, 1994, the Company announced that human trials were to commence at the University of Naples ("Naples"). However, after the termination of Joseph S. Latino's employment with the Company, the Company's inquiry into the conduct of its operations during Dr. Latino's tenure as its Chairman, President and Chief of Research disclosed that human clinical trials of the Company's ozone therapy on patients infected with either Acquired Immunodeficiency Syndrome (AIDS) or Hepatitis B (chronic active) has not been authorized by Naples or commenced at that institution. The Company also learned that the Italian Ministry of Health had not issued approvals for human clinical trials to commence at certain sites as previously disclosed. While the ethics committees at certain university hospitals have stated their approval for the Company to conduct Phase II trials, they would require the Company to have either completed a large animal study and Phase I human clinical trials or to have these requirements waived. The Company has never performed a large animal study or Phase I human clinical trials and does not possess the necessary data with respect to its ozone therapy to commence Phase II study. However, there does exist a broad use and understanding of ozone therapy throughout Europe and there have been numerous scientific articles published in European medical journals describing the use of ozone on humans. The Company has held discussions with an Italian Contract Research Organization (the "ICRO") with a view to having the ICRO act as an intermediary on behalf the Company with the Italian Ministry of Health and prepare a written submission to the Italian Ministry of Health regarding the data in the public domain on ozone therapy with a view to having the Italian Ministry of Health accept this material as proof of safety, toxicity and tolerance of the use of the Company's ozone technology on humans in lieu of having the Company perform a large animal study and possibly even a Phase I human clinical trials. The ICRO would also design a research program and protocols for human clinical trials which would meet the standards of the European Union ("EU") and Food and Drug Administration ("FDA"), monitor the clinical terms and collect and prepare analyses of the data produced by the trials. The Company will not be able to enter into a formal contract with the ICRO unless it obtains additional funding. If the Italian Ministry of Health does not accept the published evidence on the use of ozone therapy on humans, the Company will be required to perform its own Phase I human clinical trials and possibly a large animal study. In late 1997, the Company entered into discussions with Italian and Belgium clinicians with regard to them performing Phase I human clinical trials. However, assuming the Italian Ministry of Health did not grant the Company's request for waiver, no formal agreements with these clinicians would be signed and the studies would not begin until the Company obtains additional funding. The Company estimates that it would require an infusion of approximately $1.5 million to advance the above-described research initiatives through the completion of a Phase III human clinical trials and submission of the data for approval to the Italian Ministry of Health. F-16 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. CHANGES IN MANAGEMENT CONTROL AND LITIGATION AGAINST FORMER MANAGEMENT Changes in Control - ------------------ In November 1992, four directors resigned from the Board of Directors. Two of the outgoing directors, who were the founding shareholders of the Company, were also the Company's sole officers (former management or former officers and directors), and they resigned from these management positions as well. Three new directors were elected by the outgoing directors and three new officers (new management) were then appointed on an interim basis, to serve until the formal election of directors and appointment of officers at the next annual meeting of shareholders. On July 7, 1996, at the Company's annual meeting, Joseph S. Latino, George Handel, Kenneth Gropper, John D. Pealer and Richard G. Solomon were elected to the Company's Board of Directors. On July 31, 1996, Lawrence I. Sosnow and Howard L. Feinsand were appointed to the Company's Board of Directors. Mr. Sosnow and Mr. Feinsand resigned as directors on October 1, 1996 and March 26, 1997, respectively. Richard G. Solomon resigned as a director on February 27, 1997. On May 14, 1997, the Company's Board of Directors terminated the employment of Joseph L. Latino ("Latino") as the Company's President and Chairman after the discovery of a pattern of unaccounted for expenditures of the Company's funds. The Company is investigating the purposes, nature and extent of such expenditures. Dr. Latino remained a director of the Company until he resigned in August 1997. George Handel ("Handel") was named President and Chairman and served as such until May 19, 1997 when Kenneth Gropper ("Gropper") assumed these positions. Contemporaneously with the above events, the Company was notified that The Sand Dollar Solution, a California limited partnership ("Sand Dollar"), whose general partner is Edwin G. Marshall ("Marshall"), was soliciting shareholder proxies to vote for Marshall, Milton G. Adair ("Adair"), Gerard V. Sunnen, M.D. ("Sunnen") and William M. Hitt, Ph.D., M.D. ("Hitt") as directors. On June 12, 1997, the Company's Board of Directors appointed Marshall, Adair, Sunnen and Hitt to the Company's Board of Directors, with Marshall being named Chairman. Contemporaneously thereto, John Pealer ("Pealer") resigned as a director, and Gropper resigned as President. George Handel resigned from the Board effective June 13, 1997. The Board thereupon made the following appointments to the following positions: President and Chief Executive Officer Milton G. Adair Chief Operating Officer Kenneth Gropper Secretary Gerard V. Sunnen, M.D, On November 5, 1997, the Board eliminated the position of Chief Operating Officer. Gropper remains as a Director of the Company. F-17 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. CHANGES IN MANAGEMENT CONTROL AND LITIGATION AGAINST FORMER MANAGEMENT (Continued)- Litigation Against Former Management - ------------------------------------ In November 1992, a derivative action was filed in the U.S. District Court for the District of New Jersey by two shareholders of the Company against two of its former officers and directors. The Company was named as a nominal defendant in the action but in January 1993, the Company substituted itself as a real party plaintiff. The Company filed an amended complaint seeking damages and equitable remedies and alleging, among other things, that the former officers and directors defrauded the Company, breached fiduciary duties owed to the shareholders, and committed violations of federal securities laws. In November 1993, the defendants replied to the counterclaims asserted by the Company. The reply contained additional counterclaims seeking monetary and injunctive relief under various provisions of the federal securities laws and the common law. The defendants also asserted a derivative counterclaim on behalf of the Company against certain current and former directors based upon alleged breaches of a written agreement between the defendants and the Company's board of directors. Although the claims originally asserted by the defendants in the New York action sought only declaratory relief, the newly asserted claims sought damages in excess of $2.0 million. On May 18, 1994, the parties reached agreement in principle to settle all their litigation. On September 27, 1994, the parties stipulated to discontinue the action pending the finalization of the settlement. On December 28, 1994, the written settlement agreement was signed. The settlement agreement provides (I) that Messrs. McGrath and Watrous will not challenge the validity of the Company's Board of Directors resolution to rescind approximately 13,000,000 shares of the Company's stock previously issued to Mr. McGrath and approximately 1,200,000 shares previously issued to Mr. Watrous and to reinstate the Company's debt to Messrs. McGrath and Watrous that had been retired by the issuance of those shares; and (ii) for the Company to acknowledge the validity of $2,033,628 of debt to Messrs. McGrath and Watrous. In connection with the settlement, Mr. McGrath assigned his portion of the above mentioned debt to Mr. Watrous, which was thereupon satisfied by the Company's issuance to Mr. Watrous of 11,250,000 shares of the Company's common stock restricted under the Securities Act of 1933. 3. GOING CONCERN Continuation of the Company as a going concern is dependent upon obtaining additional capital, obtaining the requisite approvals from the FDA and/or the EU for the marketing of ozone-related products and equipment, and ultimately, upon the Company's attaining profitable operations. The Company will require a substantial amount of additional funds to complete the development of its products, to establish manufacturing facilities, to build a sales and marketing organization and to fund additional losses which the Company expects to incur over the next several years. Because ozone-generation for the purposes of interfacing with blood and blood products is regarded as a new drug delivery system, the Company is precluded from selling or distributing Medizone (the drug) or the Medizone Technology in the United States until after FDA approval has been granted. In order to obtain FDA approval, the Company will be required to submit a New Drug Application F-18 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. GOING CONCERN (continued)- ("NDA") for review by the FDA and provide medical and scientific evidence sufficient to demonstrate that Medizone (the drug) and the Medizone Technology has been successfully used in pre-clinical studies followed by three phases of well-controlled clinical studies using human volunteer subjects. The FDA will not grant an NDA unless it contains sufficient medical evidence and data to permit a body of qualified and experienced scientists to conclude that the new drug product is safe and effective for its recommended and proposed medical uses. Historically, the FDA has held a strong bias against treating humans with ozone, due largely to issues of safety. In order to initiate the first phase (i.e., Phase I) of human clinical trials required as part of an NDA, an applicant must submit to the FDA an application for an Investigational New Drug Exemption ("IND"), which contains adequate information to satisfy the FDA that human clinical trials can be conducted without exposing the volunteer human subjects to an unreasonable risk of illness or injury. The Company submitted an IND application (assigned to the Company by its former president) to the FDA on October 6, 1985, and requested FDA approval to commence human clinical trials using ozone-oxygen to inactivate HIV. The FDA deemed the IND application to be incomplete, and required the Company to conduct additional animal studies prior to commencing a large animal study and human trials. In September 1994, after not receiving responses to requests for information from the Company, the FDA inactivated the Company's IND. The Company has no present plans to commence a large animal study, which would require, as a precursor, additional small animal and laboratory work. Accordingly, there can be no assurance that the Company's IND application will ever be re-opened. Until an NDA has been granted to the Company, it may not distribute ozone-generating devices, except to researchers who agree to follow FDA guidelines, and provided the devices are labeled as "Investigational Devices." Because ozone has been used to treat humans in Europe for at least 30 years, the EU is more accepting of human clinical trials of ozone therapies being conducted than is the United States. Accordingly, Management believes that the Company should pursue the option of conducting human clinical trials in Europe, using stringent protocols that will meet EU standards, with a view to utilizing the results of such a trial in an effort to obtain EU approval, to market the product in Europe and to re-open the Company's FDA file. The management of the Company intends to seek additional funding which will be utilized to fund additional research and continue operations. The Company recognizes that, if it is unable to raise additional capital, it may find it necessary to substantially reduce or cease operations. 4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation - --------------------------- The consolidated financial statements include the accounts of the Company MCL, a 66.6% owned subsidiary, and Medizone-Delaware (an inactive company). Intercompany transactions have been eliminated. Cash and Cash Equivalents - ------------------------- The Company considers all highly liquid instruments purchased with a maturity at the time of purchase of less than three months to be cash equivalents. F-19 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)- Fixed Assets - ------------ Fixed assets are stated at cost. Depreciation is computed using the straight-line method over five years for office equipment and ten years for furniture and fixtures. Maintenance and repairs are charged to expense as incurred. Upon retirement or sale, the cost of the assets disposed and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to income. Other Assets - Organization Costs - --------------------------------- Organization costs were deferred and amortized over a 60-month period on a straight-line basis. Loss per Share - -------------- The computation of primary loss per share of common stock is based on the weighted average number of shares outstanding during the period. Stock-Based Compensation - ------------------------ In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation. The Company currently accounts for its stock-based compensation plans using the accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Since the Company is not required to adopt the fair value based recognition provisions prescribed under SFAS No. 123, it has elected to comply with the disclosure requirements set forth in the Statement, which includes disclosing pro forma net income as if the fair value based method of accounting had been applied. (See Note 8.) Estimates and Assumptions - ------------------------- Management uses estimates and assumptions in preparing financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could vary from the estimates that were assumed in preparing the financial statements. 5. OTHER ASSETS Patent - ------ In March 1987, the Company acquired a patent from Immunologics Limited Partnership in exchange for 1,000,000 shares of the Company's common stock. In 1988, Immunologics purchased for $25,000, 5,000,000 shares of the Company's common stock from the former Chairman and Chief Executive Officer of the Company. F-20 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 5. OTHER ASSETS (continued)- Patent (continued) - ------ The patent covers a procedure for "ozone decontamination of blood and blood products" through the treatment of stored blood and blood components. The Board of Directors assigned a value of approximately $700,000 to the patent based upon the fair market value of the stock on the date of acquisition together with related legal costs. The Company charged the cost of the patent to research and development expense at acquisition because the technologies covered by the patent have not been approved by the FDA. Additionally, the Company agreed to pay the seller a royalty fee equal to 3% of the net receipts received by the Company in connection with the sale of any product, device or apparatus which embodies the patent. The Company's management considers the acquisition and retention of the patent to be material in its development and prospects. In 1992, the General Partner of Immunologics became chairman of the Company's Board of Directors and subsequently resigned from the Company's Board of Directors in September 1993. License Agreement - ----------------- On February 4, 1986, Medizone, in exchange for shares of its common stock, acquired from a principal stockholder his interest in a license agreement covering the distribution of ozone-generating equipment. The license agreement was carried at $1.00 through December 31, 1991; as that was the stockholder's basis, and was written off as of December 31, 1992. 6. COMMITMENTS AND CONTINGENCIES (See also Notes 7 and 10) On May 14. 1997, the employment contract of the Company's former President and Chief Operating Executive Officer was terminated for cause. The Company hired a new President and Vice President of Operations (who is not a corporate officer) at annual salaries of $200,000 and $65,000 respectively, The Company does not have a written employment agreement with its President or Vice President of Operations. The employment contract of the Company's Vice President, Treasurer and Chief Financial Officer for an annual salary of $72,000 plus expenses has remained unchanged. In 1997 and 1996, the Company had employment contracts with two officers. The former President and Chief Operating Officer was paid $180,000 annually and was reimbursed monthly for expenses related to a leased automobile. The Vice President, Treasurer and Chief Financial Officer is paid $72,000 annually, plus expenses. The Company retains an investor relations firm to act as the Company's liaison with the brokerage community. The agreement is for a period of one year, but may be extended by the parties for additional one year periods. It receives a monthly payment of $2,000, plus expenses. As additional compensation in 1996, it received 250,000 shares of the Company's common stock, restricted under the federal securities laws. In 1994, the Company had consulting relations with two officers. The President and Chief Operating Officer was paid $72,000 annually and was reimbursed monthly for expenses related to a leased automobile. The Vice President, Treasurer and Chief Financial Officer was paid $36,000 annually. F-21 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 6. COMMITMENTS AND CONTINGENCIES (See also Note 7 and 10) (continued)- From November 17, 1992 through December 31, 1994 the Company maintained a consulting relationship with the Company's Vice President, who is also Treasurer and Chief Financial Officer, whereby the Company was billed in connection with accounting services provided by a private company owned by the Company's Vice President. For the year ended December 31, 1996, the Company leased from an unaffiliated party, office space in New York City under a two-year lease expiring on February 28, 1998, at an annual rental of approximately $21,000. The Company terminated this lease in June 1997 and paid $4,599 to the landlord in settlement of any claim for unpaid rent under the lease. On September 23, 1997, the Company entered into a three-year lease with an unaffiliated third party for its present offices in Salt Lake City at an annual rent of approximately $23,000. The office is used for executive offices and administrative purposes. Future minimum rental commitments pursuant to this lease are as follows: Year Ended December 31, Amount ------------ ------ 1997 $ 5,746 1998 23,214 1999 24,144 2000 18,649 Total $ 71,753 ======= During 1992, a financial consulting entity agreed to raise equity financing for Medizone. An agreement was executed requiring the Company to tender $50,000 to a third party whose obligation was to hold the funds in escrow pending completion of the financing; however, these sums were not tendered at that time. In the event of completion of the financing, the $50,000 would be released from escrow to the consultant to defray legal fees of the consultant. In the event the financing failed to be completed, the funds were to be returned to the Company. In a separate transaction during 1992, the Company sold 250,000 shares of common stock to five investors for $50,000, and caused the proceeds to be paid directly to the third party in the pending financing transaction. Medizone acknowledged constructive receipt of the funds by executing stock purchase agreements and the 250,000 shares were subsequently issued in 1993. Since the financing was not completed and the funds were not returned to the Company, the $50,000 has been expensed in the Company's financial statements. On or about June 6, 1994, Maureen Abato, the Company's former outside counsel, filed suit in the Supreme Court of the State of New York, County of New York entitled Abato V. Medizone International, Inc., Medizone Canada, Ltd. and Joseph S. Latino. The complaint contains thirteen causes of action. Three of the causes of action are for breach of contract, account stated and quantum meruit for recovery of unpaid legal fees allegedly due plaintiff by the Company in the amount of $67,864. The remaining claims are for fraud, wrongful termination, sexual discrimination, defamation, tortious interference with contract and intentional infliction of emotional distress. With respect to each of these causes of action, plaintiff seeks unspecified compensatory damages and punitive damages of not less than $1 million. On October 24, 1994, the Company and the other defendants moved for partial summary judgment dismissing all of plaintiff's claims except her legal fee claim based on quantum meruit. By decision and order dated February 14, 1995, the Court dismissed all of the plaintiff's claims except for breach of contract and F-22 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 6. COMMITMENTS AND CONTINGENCIES (See also Note 7 and 10) (continued)- for an account stated; however, the court limited plaintiff's claim to her actual damages and dismissed her claim for punitive damages on these counts. In addition, the court dismissed these claims in their entirety as against Medizone Canada, Ltd. and Dr. Latino. A Stipulation of Settlement was executed by the parties, dated October 30, 1995, whereby the Company agreed to pay $61,000 in full settlement of all remaining claims, to be paid as follows: November 15, 1995 $20,000 December 15, 1995 5,000 January 15, 1996 5,000 February 15, 1996 5,000 March 15, 1996 5,000 April 15, 1996 5,000 May 15, 1996 5,000 June 15, 1996 5,000 July 15, 1996 6,000 ------- Total $ 61,000 ======= As of the date of this report, all payments have been made in full. On November 10, 1995, the plaintiff executed a release against Medizone International, Inc., Medizone Canada Ltd. and Joseph S. Latino. 7. ISSUANCE OF COMMON STOCK AND WARRANTS Unless otherwise stated, all transactions shown below were with unrelated parties and the securities issued were restricted. Madison initially issued 1,500,000 shares in a private transaction for proceeds of $3,000. In May 1985, Madison sold in a public offering, 4,000,000 shares of common stock and 8,000,000 warrants to purchase a common stock at $0.10 per share. The proceeds from the offering to Madison were $200,000. The costs of the offering were offset against paid-in capital. On March 26, 1986, Madison issued 37,500,000 shares of common stock, representing 87.2% of the then outstanding shares, to the stockholders of Medizone, including two officers and directors, in exchange for all of the shares of Medizone. The costs of the transactions were offset against paid-in capital. In July 1986, the Company issued 50,000 shares of common stock to individuals for services rendered. During the period from August 1986 through October 31, 1986, the final expiration date for exercise, warrants to purchase 7,814,600 shares together F-23 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. ISSUANCE OF COMMON STOCK AND WARRANTS (continued)- with cash totaling $781,460 were received by the Company which then issued 7,814,600 shares of new common stock. In January 1987, an additional 2,600 shares were issued in exchange for warrants and cash of $259. In March 1987, the Company issued 1,000,000 shares of common stock in exchange for a patent (see Note 5). In June 1987, the Company issued 950,000 shares to individuals in private transactions for aggregate proceeds of $150,000. During the period from June 1987 through July 1987, the Company issued 203,167 shares of common stock to various vendors and individuals for services rendered in 1986 and 1987. On August 26, 1987, an officer of the Company exercised options to purchase 250,000 shares of common stock. In January 1988, two holders exercised their options and acquired an aggregate of 200,000 shares of common stock. On September 26, 1988, the Company sold, in a private placement, 1,000,000 shares of common stock at $0.08 per share to an individual. During 1988, the Company issued a total of 35,000 shares of common stock for services. During 1989, the Company issued 261,889 shares of common stock to various vendors and individuals for services rendered in 1988 and 1989. During 1989, the Company issued 5,790,000 shares to individuals in private transactions for aggregate proceeds of $291,500. Also during 1989, the Company satisfied obligations for notes payable to and accrued interest due to unrelated individuals totaling $377,539 by the issuance of 3,899,532 shares of common stock. The Company issued 250,000 shares of common stock to an officer and 600,000 shares of common stock to three advisors to the Company as additional compensation for work done for the Company. These issuances were ascribed values of $60,650 and $145,539, respectively, by the Company. Also during 1989, two holders exercised their options and acquired an aggregate of 375,000 shares of common stock. During 1990, the following equity transactions occurred: The Company issued 4,250,000 shares to individuals in private transactions for aggregate proceeds of $179,500; the Company satisfied obligations totaling $125,000 to the former vice president, secretary and treasurer as well as director by issuing 2,272,727 shares of common stock at $0.55 per share; the Company satisfied an outstanding account payable to an unrelated individual totaling $15,000 by the issuance of 150,000 shares of common stock at $0.10 per share; and the Company issued to an employee and four other unrelated persons as compensation or payment a total of 880,000 shares of common stock to which it ascribed a value of $88,000. During 1991, the following equity transactions occurred: The Company issued 4,366,667 shares to individuals in private transactions for aggregate proceeds of $310,000; the Company issued a total of 425,000 shares of common stock for services and accrued liabilities of which an aggregate of 100,000 shares were issued to two directors; and three holders exercised their options and acquired an aggregate of 450,000 shares of common stock. F-24 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. ISSUANCE OF COMMON STOCK AND WARRANTS (continued)- During 1992, the following equity transactions occurred: The Company issued 2,702,335 shares to individuals in private transactions for aggregate proceeds of $430,350; the Company issued a total of 401,500 shares of common stock for services and accrued liabilities; holders exercised options and acquired an aggregate of 250,000 shares of common stock. Also, during 1992, 13,118,619 restricted shares of the Company's stock were issued pursuant to an approval by the Company's board of directors in December 1989 to the former president, chief executive officer and board chairman for the settlement of $813,367 of advances made to the Company. During 1993, the following equity transactions occurred: The Company issued 1,471,666 shares to individuals in private transactions for aggregate proceeds of $271,000; the Company issued a total of 5,347,219 shares of common stock for services; the Company canceled the 13,118,619 shares of common stock issued in 1992 to the former president, chief executive officer and board chairman. As a result of this cancellation of shares, the debt that was removed from the Company books when the shares were issued, was restored. The restored debt was $813,367. Also, during 1993, a total of $261,915 was received in cash for 2,619,150 shares subscribed as a result of a private placement offering (Offering). The Offering commenced as of November 26, 1993, with a maximum of $700,000 to be raised in gross proceeds from the sale of up to 7,000,000 shares. During 1994, the following equity transactions occurred: The Company issued a total of 1,431,590 shares of common stock for services; the Company issued a total of 1,125,834 shares of common stock to certain prior purchasers of common stock in recognition of disparity in purchase in contemporaneous Offering. Also during 1994, a total of $680,040 was received in cash for 6,800,499 shares subscribed as a result of the Offering. Subsequent to the Offering, an additional $316,860 was received in cash from foreign investors subscribing to 3,168,600 shares of common stock. On December 28, 1994, the Company settled a dispute regarding the validity of notes payable to former management in the amount of $2,033,628 (see Note 2) by agreeing to issue 11,250,000 common shares (recorded as shares subscribed) in satisfaction of the total amount of the debt. Also in 1994, $40,000 of notes payable (a portion of loans totaling $60,000) together with interest, was satisfied by issuing 416,500 shares of common stock. (See Note 10.) During 1995, the following equity transactions occurred: The Company issued a total of 2,050,000 shares of common stock for services. $911,825 was received from investors subscribing to 9,118,260 shares of common stock. Also, 7,524,860 common shares, previously recorded as shares subscribed, were issued, and 1,242,727 were retired in accordance with the settlement agreement with former management (see Note 2). Two hundred thousand of redeemable shares were converted into common stock. The Company sold shares of its New Zealand subsidiary for aggregate proceeds of $150,000. During 1996, the Company received stock subscription agreements for the purchase of 7,254,470 shares of its common stock, together with proceeds totaling $725,447 from sales of its securities to non-United States investors, outside of the United States pursuant to Regulation S promulgated under the Securities Act of 1993 (the "Securities Act"). Approximately $635,447 of these proceeds were from the sale of the Company's common stock at a per share price of $.10 (including $37,500 for 375,000 shares from Richard G. Solomon, at the time a director of the Company). The remaining $90,000 were from the sale of 900,000 Units, each Unit consisting of one share of the Company's common stock, $.001 par value, at a per share price of $.10 to a director pursuant to the non-public F-25 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. ISSUANCE OF COMMON STOCK AND WARRANTS (continued)- offering exemption from registration under the Securities Act. In May 1996, the Company issued 600,000 shares of its common stock to employees and 250,000 shares of its common stock to its public relations consultant as additional compensation. The Company also issued 565,875 shares of its common stock to various consultants for services rendered. During 1997, the Company issued 3,089,680 previously subscribed shares of its common stock and also issued 3,746,336 shares of its common stock to various consultants for services rendered. Also, in 1997, the Company received $400,000 for subscriptions to acquire 5,714,285 shares of its common stock and warrants to purchase 8,428,571 shares of common stock at $.07 per share, 25,000,000 shares at $.20 per share, and 33,333,333 shares at $.15 per share. 8. STOCK OPTIONS During 1986, the Company granted nonqualified options to a number of persons, consisting of an officer, employee and consultants to the Company, to purchase an aggregate of 1,150,000 shares of common stock of the Company at an initial exercise price of $.25 per share, the estimated fair value at the date of grant. During 1988, the Company granted a nonqualified option to a newly appointed member of the Board of Directors of the Company to purchase an aggregate of 150,000 shares of common stock of the Company at an exercise price of $.001 per share. The options were exercisable 50,000 shares on each of November 29, 1989, 1990 and 1991 and were to expire on November 29, 1994. This director exercised the option which became exercisable on November 29, 1989 and resigned on January 22, 1990. During 1989, in consideration for services rendered over the prior three years, the Company granted to a member of it Scientific Advisory Board a nonqualified option to purchase 325,000 shares of common stock of the Company at an exercise price of $.001 per share. This option was exercised in 1989. During 1990, in consideration for services rendered over the prior four years, the Company granted to a member of its Scientific Advisory Board a nonqualified option to purchase 150,000 shares of common stock of the Company at an initial exercise price of $.10 per share. This option was exercised in 1991. All options were exercisable for a period of five years beginning one year from the date of grant. Compensation expense, measured as to the excess of the estimated fair value over the exercise price, was accrued over the service period. If, on the date of exercise, the estimated fair value of a share of the Company's common stock exceeded the exercise price, the exercise price was decreased by a like amount (but not below the par value of $.001). At the end of each fiscal period, total accrued compensation was recorded as the difference between the adjusted exercise price and the fair market value at the end of the period for all exercisable shares. The total accrued compensation was adjusted each year for changes in the fair market value of the Company's stock and for option exercises and cancellations. The shares issued in connection with the exercise of the options were restricted shares to be held for investment purposes only. In 1995, as part the their employment agreements, the Company's president and chief executive officer, and vice- president and chief financial officer and F-26 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 8. STOCK OPTIONS (continued)- treasurer, were granted options to purchase an aggregate of 4,500,000 shares of the Company's common stock at an exercise price of $.20 per share, which vest fully on January 1, 1998 over the following vesting schedule; 33% on January 1, 1996, 33% on January 1, 1997, and 33% on January 1, 1998. The fair value of each option grant is estimated on the grant date using an option-pricing model with the following weighted-average assumptions used for grants in 1995: risk-free interest rate of 6%, and expected lives of 3 years for the options. The following is a summary of option transactions: Weighted Average Fixed Options Shares Exercise Price Balance - January 1, 1996 4,500,000 $ .20 Granted - Employees -- -- Exercised -- -- Forfeited - -- -- ----------- Balance - December 31, 1996 4,500,000 -- Granted - Employees -- -- Exercised -- -- Forfeited (3,000,000) -- Balance - December 31, 1997 1,500,000 .20 ========== Exercisable at December 31, 1997 1,500,000 ========== Weighted-average fair value of options granted during the year $ -- ========== The following table summarizes information about fixed stock options outstanding at December 31, 1997:
Outstanding Options Exercisable Options - ------------------------------------------------------------ --------------------------- Weighted- Average Number Remaining Weighted- Number Weighted- Range of Outstanding Contractual Average Exercisable Average Exercisable Prices 12/31/97 Life Exercise Price at 12/31/97 Exercise Price - ------------------ -------- ---- -------------- ----------- -------------- $.20 1,500,000 3 years $.20 1,500,000 $.20
If the Company had used the fair value based method of accounting for its employee stock option plan, as prescribed by Statement of Financial Accounting Standard No. 123, compensation cost in net loss for the year ended December 31, 1997 and 1996 would have increased by $72,338 and $242,387, respectively, and the Company's net loss and loss per share would have been reduced to the pro forma amounts indicated below: 1997 1996 -------- ---------- Net loss As reported $775,559 $1,329,395 Pro forma $703,221 $1,571,782 Net loss per share As reported $(.01) $(.01) Pro forma $(.01) $(.01) F-27 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. MINORITY INTEREST In June 1988, MCL issued 2,000,000 units consisting of one share of common stock and two warrants which allow the holder to purchase one share of common stock per warrant. The warrants are exercisable at $.125 per share. The net proceeds of this offering were $84,024. The warrants were originally scheduled to expire on December 31, 1992 but were extended to December 31, 1995. In 1988, MCL issued 1,938,000 shares of common stock at $.005 per share to a consultant for services rendered. Following these transactions, the Company's ownership of MCL was 72.2%. In 1990, MCL issued 983,333 shares of common stock at prices ranging from $.05 to $.075 in private offerings to two individuals unrelated to MCL for proceeds of $57,400. MCL also issued 850,000 shares to five individuals, 550,000 shares to the three directors of MCL, 50,000 shares to an employee, and 250,000 shares to a consultant for services rendered to which MCL assigned the value of $.05 per share for an aggregate of $42,500. Following these transactions, the Company's ownership of MCL was 68,6%. These transactions had previously been incorrectly reported as minority interest. Minority interest should not have been recorded on the balance sheet because of the magnitude of the stockholders' deficiency of these stockholders. Accordingly, amounts previously stated as minority interest have been restated to additional paid-in capital. 10. NOTES PAYABLE Short-term debt at December 31, 1997 and 1996 consisted of the following:
1997 1996 ---- ---- Notes payable to ten stockholders, due on demand, plus interest at 10% per annum (in arrears). The Company is obligated to accept the rate at face value plus accrued interest as partial payment for shares the lender may purchase from the Company upon exercise of the lender's option to acquire shares from the Company. $60,815 $60,815 Notes payable to directors totaling $28,000 and a note payable to a third party in the amount of $9,000, due on April 22, 1995 (principal and accrued interest in arrears as of report date), plus interest ranging from 8% to 9% per annum. Each lender has the right to convert any portion of the principal and interest into common stock at a price per share equal to the price per share under the most recent private placement transaction. 37,000 37,000 Notes payable to directors and a family member of a director, due at various dates in 1995, 1996 and 1997 (principal and accrued interest in arrears as of report date), plus interest at 8% per annum. The Company has the right to repay the loans with restricted stock at $.10 per share if alternative financings do not occur. 216,300 194,500
F-28 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. NOTES PAYABLE (continued)-
1997 1996 ---- ---- Note payable to individual, due on December 2, 1996 (principal and accrued interest in arrears as of report date), plus interest at 6.07% per annum. The Company has the right, on or after the payment due date, to repay the loan with restricted shares valued at $.05 per share. 40,000 40,000 Total short-term debt $354,115 $332,315
11. RESTATEMENTS OF PRIOR PERIODS (Unaudited) Beginning in 1991, the Company began selling off its holdings of MCL to raise cash for operations. The Company sold 100,000 and 610,000 shares of MCL's common stock during 1991 and 1992, respectively, through a broker for $5,000 and $81,100 at $.05 per share in 1991 and per share prices ranging from $.093 to $.179 in 1992. Because the Company's investment in MCL was only $2, the entire $5,000 and $81,100 were recorded as gains in the Company's statement of operations during the fourth quarter of 1991 and the first three quarters of 1992, respectively. During the fourth quarter of 1992, an adjustment was made to classify these sales as equity transactions. The effect of these restatements is as follows:
Three Months Ended ----------------------------------------------------------------------------------------- December 31, 1991 March 31, 1992 June 30, 1992 September 30, 1992 December 31, 1992 ----------------- -------------- ------------- ------------------ ----------------- Net loss: Previously reported $1,215,200 $ 151,930 $ 173,496 $ 147,905 $ 89,510 Adjustment 5,000 24,555 - 24,470 32,075 As adjusted $1,220,200 $ 176,485 $ 173,496 $ 172,375 $ 121,585
These restatements do not affect previously reported loss per share because of rounding. See Note 9 for restatement of minority interest in prior years. The Company has restated its financial statements to reflect adjustments to write off liabilities which were accrued and expensed in years prior to fiscal 1992. These adjustments increased previously reported accumulated deficit and reduced previously reported results of operations (for the period January 31, 1986, date of inception, through December 31, 1994) by $219,422. During the first quarter of 1995, the Company recorded a further reduction to accumulated deficit in the amount of $71,806 relating to the cancellation of shares previously issued to former management. F-29 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. INCOME TAXES The components of the provision for income taxes are as follows: From the Date of Inception (January 31, 1986) through December 31, 1997 1997 1996 1995 (Cumulative) ---- ---- ---- -------------------------- Current tax expense $ - $ - $ - $ - Deferred tax expense - - - - ------ ------- ------- --------- Income tax expense $ - $ - $ - $ - ====== ======= ======= ========= A reconciliation of the consolidated income tax expense on income per the U.S. Federal Statutory rate to reported income tax follows: 1997 1996 1995 Cumulative ---- ---- ---- ---------- Taxes at U.S. Federal Statutory rate $ - $ - $ - $ - State income taxes - - - - --------- --------- --------- --------- $ - $ - $ - $ - ========= ========= ========= ========= At December 31, 1997 and 1996, deferred tax assets (liabilities) consisted of the following: 1997 1996 ------ ------ Current deferred tax liabilities $ - $ - Noncurrent deferred tax liabilities - - Current deferred tax assets 1,748,419 1,651,738 Noncurrent deferred tax assets - - Valuation allowance (1,748,419) (1,651,738) --------- --------- $ - $ - ========= ========= At December 31, 1997, the Company has a net operating loss (NOL) carryforward totaling approximately $11,275,000 that may be offset against future taxable income in varying amounts through 2006 No benefit has been reported in the 1997 or 1996 financial statements, however, because the Company believes there is at least a 50% chance that the carryforward will expire unused. Accordingly, the tax benefit of the loss carryforward has been offset by a valuation allowance of the same amount. The expected tax benefit that would result from applying federal statutory tax rates to the pretax loss differs from amounts reported in the financial statements because of the increase in valuation allowance. Under certain circumstances, Section 382 of the Internal Revenue Code of 1986 restricts a corporation's use of its NOL carryforward. Due to the Company's issuance of additional stock, the Company's use of its existing NOL carryforward could be limited. Therefore, the Company may have to pay federal income taxes sooner than if the use of its NOL carryforward were not restricted. 13. REDEEMABLE COMMON STOCK On February 12, 1993, per a settlement agreement (Agreement), the Company issued 200,000 shares of restricted common stock to an unrelated third party (Party). According to the Agreement, if net funds available specified in the Agreement. If the Company files a registration statement for an offering of its securities, it must use its best efforts to include such shares in the registration F-30 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. REDEEMABLE COMMON STOCK (continued)- statement. If all, or any portion of the shares have not been purchased by the Company pursuant to the exercise of the put option described above, or all the shares have not been covered by an effective registration, then the Company shall be required to pay, no later than April 13, 1995, an amount equal to the lesser of $50,000 minus the aggregate purchase price amount payable under the formula set forth in the Agreement, or $25,000. In September 1995, the Company paid $5,000 and issued 200,000 shares of restricted common stock in full and final settlement of the Agreement. 14. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reflected in the consolidated balance sheets for cash, receivable from affiliate, accounts payable and notes payable approximate the respective values. The estimated fair values have been determined by the Company using appropriate valuation methodologies and available market information. Considerable judgment is necessarily required in interpreting market data to develop the estimates of fair value, and, accordingly, the estimates are not necessarily indicative of the amounts that the Company could realize in a current market exchange. A comparison of the carrying value of those financial instruments, none of which are held for trading purposes, is as follows: Carrying Fair Amount Value Assets: Cash $ 138,173 $ 138,173 Receivable from affiliate 48,947 48,947 Carrying Fair Amount Value -------- ----- Assets: Cash $ 138,173 138,173 Receivable from affiliate 48,947 48,947 Liabilities: Accounts payable and liabilities 739,071 739,071 Short-term debt 354,115 354,115 Cash, receivable from affiliate and accounts payable. The carrying value of such items approximates their fair value at December 31, 1997. Short-term debt. Fair value of such debt is based on rates currently available to the Company for debt of similar terms and remaining maturities. There are no quoted prices for the debt or similar debt. F-31 EX-27 2 ARTICLE 5 FDS FOR ANNUAL REPORT ON FORM 10-K/A
5 (This schedule contains summary financial information extracted from (A) Consolidated Balance Sheets, Statements of Operations, Changes in Stockholders Equity and Cash Flows and is qualified in its entirety by reference to such (B) annual report on Form 10-K/A for the year ended December 31, 1997) 12-MOS DEC-31-1997 DEC-31-1997 138,173 0 0 0 0 147,327 8,608 340 207,019 1,093,186 0 0 0 136,888 (1,023,055) 207,015 0 0 0 0 746,795 0 28,764 (775,559) 0 (775,559) 0 0 0 (775,559) 0 0
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